Roadmap Series

Roadmap
Share-Based Payment Awards
November 2021
The FASB Accounting Standards Codification® material is copyrighted by the Financial Accounting Foundation, 401 Merritt 7, PO Box 5116, Norwalk, CT
06856-5116, and is reproduced with permission.
This publication contains general information only and Deloitte is not, by means of this publication, rendering accounting, business, financial, investment,
legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a
basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should
consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this publication.
The services described herein are illustrative in nature and are intended to demonstrate our experience and capabilities in these areas; however, due
to independence restrictions that may apply to audit clients (including affiliates) of Deloitte & Touche LLP, we may be unable to provide certain services
based on individual facts and circumstances.
As used in this document, “Deloitte” means Deloitte & Touche LLP, Deloitte Consulting LLP, Deloitte Tax LLP, and Deloitte Financial Advisory Services LLP,
which are separate subsidiaries of Deloitte LLP. Please see www.deloitte.com/us/about for a detailed description of our legal structure.
Copyright © 2021 Deloitte Development LLC. All rights reserved.
ii

Publications in Deloitte’s Roadmap Series

Business Combinations
Business Combinations — SEC Reporting Considerations
Carve-Out Transactions
Comparing IFRS Standards and U.S. GAAP
Consolidation — Identifying a Controlling Financial Interest
Contingencies, Loss Recoveries, and Guarantees
Contracts on an Entity’s Own Equity
Convertible Debt (Before Adoption of ASU 2020-06)
Current Expected Credit Losses
Debt
Distinguishing Liabilities From Equity
Earnings per Share
Environmental Obligations and Asset Retirement Obligations
Equity Method Investments and Joint Ventures
Equity Method Investees — SEC Reporting Considerations
Fair Value Measurements and Disclosures (Including the Fair Value Option)
Foreign Currency Matters
Guarantees and Collateralizations — SEC Reporting Considerations
Hedge Accounting
Impairments and Disposals of Long-Lived Assets and Discontinued Operations
Income Taxes
Initial Public Offerings
Leases
Noncontrolling Interests
Non-GAAP Financial Measures and Metrics
Revenue Recognition
SEC Comment Letter Considerations, Including Industry Insights
Segment Reporting
Share-Based Payment Awards
Statement of Cash Flows
Transfers and Servicing of Financial Assets
iii
Contents
Prefacexiv
On the Radar xvi
Contactsxix
Chapter 1 — Overview 1
1.1 Objective 1
1.2 Substantive Terms 1
1.3 Scope 2
1.4 Recognition 3
1.5 Measurement 4
1.6 Classification 5
1.7 Nonpublic Entities 5
1.7.1 Calculated Value 6
1.7.2 Intrinsic Value 6
1.7.3 Expected Term 6
1.7.4 Transition to Public Entity 6
1.8 Comparison With IFRS Standards 7
Chapter 2 — Scope 8
2.1 General 8
2.2 Definition of Employee 12
2.3 Nonemployee Directors 14
2.3.1 Parent-Entity Directors 14
2.3.2 Subsidiary Directors 14
2.4 Nonemployee Awards 15
2.5 Economic Interest Holders 16
2.5.1 Investor Purchases of Shares From Grantees 16
2.5.2 Share-Based Payments in an Economic Interest Holder’s Equity 16
2.6 Profits Interests 19
2.7 Rabbi Trusts 22
2.7.1 Accounting for a Deferred Compensation Arrangement as Two Plans (Plans C and D) 23
2.7.2 Accounting for a Deferred Compensation Arrangement as One Plan (Plans C and D) 24
2.8 Consolidated Financial Statements 24
iv
Contents
2.9 Separate Financial Statements 25

2.10 Equity Method Investments 27
2.10.1 Accounting in the Financial Statements of the Contributing Investor Issuing the Awards 31
2.10.2 Accounting in the Financial Statements of the Investee Receiving the Awards 31
2.10.3 Accounting in the Financial Statements of the Noncontributing Investors 31
2.10.4 Accounting in the Financial Statements of the Contributing Investor Receiving the
Reimbursement32
2.10.5 Accounting in the Financial Statements of the Investee Receiving the Awards and Making
the Reimbursement 32
2.10.6 Accounting in the Financial Statements of the Noncontributing Investors (When the
Investee Reimburses the Contributing Investor) 32
2.11 Unrelated Entity Awards 32
2.12 Escrowed Share Arrangements 35
Chapter 3 — Recognition 37
3.1 General Recognition Principles 37
3.2 Determining the Grant Date 38
3.2.1 Approval 41
3.2.2 Communication Date 42
3.2.3 Unknown Conditions 43
3.2.4 Unknown Exercise Price 45
3.2.5 Discretionary Provisions 47
3.2.6 Awards Settled in a Variable Number of Shares 48
3.3 Nonvested Shares Versus Restricted Shares 49
3.4 Vesting Conditions 50
3.4.1 Service Condition 51
3.4.1.1 Estimating Forfeitures 54
3.4.1.2 Accounting for Forfeitures When They Occur 61
3.4.2 Performance Condition 63
3.4.2.1 Performance Conditions Associated With Liquidity Events 64
3.4.2.2 Performance Conditions Satisfied After the Requisite Service Period or the
Nonemployee’s Vesting Period 65
3.4.3 Repurchase Features That Function as Vesting Conditions 66
3.5 Market Condition 68
3.6 Requisite Service Period for Employee Awards 70
3.6.1 Explicit Service Period for Employee Awards 73
3.6.2 Implicit Service Period for Employee Awards 73
3.6.3 Derived Service Period for Employee Awards 74
3.6.4 Service Inception Date 75
3.6.4.1 Award Authorization 77
3.6.4.2 Service Begins 79
3.6.4.3 No Substantive Future Requisite Service as of the Grant Date 79
3.6.4.4 Forfeiture Because a Market or Performance Condition Was Not Satisfied Before
the Grant Date 79
3.6.4.5 Recognition of Compensation Cost 81
v
Deloitte | Roadmap: Share-Based Payment Awards (2021)
3.6.5 Graded Vesting for Employee Awards 81

3.6.6 Nonsubstantive Service Condition for Employee Awards 89
3.6.6.1 Retirement Eligibility 89
3.6.6.2 Noncompete Agreements 90
3.6.6.3 Deep Out-of-the-Money Stock Options 94
3.7 Multiple Conditions for Employee Awards 95
3.7.1 Only One Condition Must Be Met — Employee Awards 100
3.7.2 Multiple Conditions Must Be Met — Employee Awards 102
3.7.2.1 Liquidity Event and Target IRR 106
3.7.2.2 Multiple Performance Conditions That Affect Vesting and Nonvesting Factors 106
3.7.3 Multiple Conditions and Multiple Service Periods — Employee Awards 107
3.7.3.1 Multiple Performance Conditions and Multiple Service Periods 107
3.7.3.2 Multiple Service Periods Related to Exercise Price 108
3.7.3.3 Multiple Service Periods Related to Transferability 109
3.8 Changes in Estimate for Employee Awards 110
3.9 Clawback Features 112
3.10 Dividend Protected Awards 115
3.11 Nonrecourse and Recourse Notes 119
3.11.1 Recourse Notes 119
3.11.2 Nonrecourse Notes 119
3.11.3 Changes Made to the Note 120
3.11.4 In-Substance Nonrecourse Note 121
3.11.5 Combination Recourse and Nonrecourse Loan 121
3.12 Employee Payroll Taxes 121
3.13 Capitalization of Compensation Cost 122
Chapter 4 — Measurement 123

4.1 Fair-Value-Based Measurement 123
4.1.1 Vesting Conditions 124
4.1.2 Reload and Contingent Features 126
4.2 Measurement Objective 128
4.3 Observable Market Price 132
4.4 Measurement Date 133
4.5 Market Conditions 133
4.6 Conditions That Affect Factors Other Than Vesting or Exercisability 138
4.6.1 Market, Performance, and Service Conditions 139
4.6.2 Other Conditions 146
4.7 Nonvested Shares 146
4.8 Restricted Shares 147
4.8.1 Options on Restricted Shares 149
4.8.2 Limited Population of Transferees 150
vi
Contents
4.9 Option Pricing Models 150

4.9.1 Change in Valuation Technique 154
4.9.2 Assumptions in an Option Pricing Model 156
4.9.2.1 Risk-Free Interest Rate 159
4.9.2.2 Expected Term 159
4.9.2.3 Expected Volatility 172
4.9.2.4 Expected Dividends 183
4.9.2.5 Credit Risk and Dilution 184
4.9.3 Market-Based Measure of Stock Options 185
4.10 Valuation of Awards With Graded Vesting Schedule 185
4.11 Difficulty of Estimation 186
4.12 Valuation of Nonpublic Entity Awards 187
4.12.1 Cheap Stock 187
4.12.2 ISOs, NQSOs, and Internal Revenue Code Section 409A 188
4.12.3 Purchases of Shares From Employees 190
4.12.3.1 Entity Purchases of Shares From Employees 190
4.12.3.2 Investor Purchases of Shares From Grantees 190
4.12.4 Interpolation Considerations for Valuing Share-Based Compensation 195
4.13 Practical Expedients for Nonpublic Entities 199
4.13.1 Application 199
4.13.1.1 Fair-Value-Based Measurement Exceptions 200
4.13.1.2 Expected-Term Practical Expedient 200
4.13.2 Calculated Value 200
4.13.3 Intrinsic Value 205
4.13.4 Transition From Nonpublic to Public Entity Status 208
Chapter 5 — Classification 212

5.1 General 212
5.2 ASC 480 214
5.2.1 ASC 480 Scope Exceptions That Apply to Share-Based Payments Within the Scope of ASC 718 218
5.3 Share Repurchase Features 218
5.3.1 Repurchase Features — Puttable Stock Awards 221
5.3.1.1 Repurchase Features — Noncontingent Puttable Stock Awards 222
5.3.1.2 Repurchase Features — Contingently Puttable Stock Awards 225
5.3.2 Repurchase Features — Callable Stock Awards 227
5.3.2.1 Repurchase Features — Noncontingent Callable Stock Awards 228
5.3.2.2 Repurchase Features — Contingently Callable Stock Awards 230
5.3.3 Book-Value Plans for Employees 232
5.3.4 Repurchase Features That Function as Vesting Conditions or Clawback Features 233
vii
5.4 Stock Options 233

5.4.1 Classification of Underlying Shares 233
5.4.2 Cash Settlement Features 233
5.4.2.1 Noncontingent Cash Settlement Features (Including Tandem and Combination Awards) 237
5.4.2.2 Contingent Cash Settlement Features 240
5.4.2.3 Early Exercise of a Stock Option or Similar Instrument 241
5.4.3 Net Share Settlement Features 242
5.4.4 Broker-Assisted Cashless Exercise 242
5.5 Indexation to Other Factors 243
5.6 Substantive Terms 245
5.7 Exceptions to Liability Classification 246
5.7.1 Foreign Currency 246
5.7.2 Statutory Tax Withholding Obligation 247
5.7.2.1 Hypothetical Withholdings 248
5.7.2.2 Cash Settlement of Fractional Shares 248
5.7.2.3 Changes in the Amount Withheld 248
5.7.2.4 Nonemployee Director Tax Withholdings 249
5.8 Awards That Become Subject to Other Guidance 249
5.8.1 Awards Modified When the Grantee Is No Longer Providing Goods or Services 251
5.8.2 Equity Restructurings 251
5.9 Change in Classification Due to Change in Probable Settlement Outcome 252
5.10 SEC Guidance on Temporary Equity 253
Chapter 6 — Modifications 263

6.1 Accounting for the Effects of Modifications 263
6.1.1 The Fair Value Assessment 272
6.1.1.1 Determining Whether a Fair Value Calculation Is Required 272
6.1.1.2 Considering Whether Compensation Cost Recognized Has Changed 272
6.1.1.3 Determining the Unit of Account 272
6.1.1.4 Determining Whether the Fair Value Is the Same Before and After Modification 273
6.1.2 Examples of Changes for Which Modification Accounting Would or Would Not Be Required 274
6.1.3 Tax Effects of Award Modifications 275
6.2 Modification Date 275
6.3 Impact of Vesting Conditions 276
6.3.1 Probable-to-Probable Modifications 278
6.3.2 Probable-to-Improbable Modifications 280
6.3.3 Improbable-to-Probable Modifications 282
6.3.3.1 Modification in Connection With a Termination — Entity Elects to Estimate Forfeitures 284
6.3.3.2 Modification in Connection With a Termination — Entity Elects to Account for
Forfeitures When They Occur 286
6.3.4 Improbable-to-Improbable Modification 287
6.3.5 Modifications to Accelerate Vesting of Deep Out-of-the-Money Stock Options 290
viii
Contents
6.3.6 Modification of the Employee’s Requisite Service Period 291

6.3.6.1 Modification to Reduce the Employee’s Requisite Service Period of an Award 291
6.3.6.2 Modification to Increase the Employee’s Requisite Service Period of an Award 292
6.3.7 Determining the Unit of Account When Assessing the Type of Modification 293
6.4 Modification of Factors Other Than Vesting Conditions 295
6.4.1 Modification of a Market Condition 295
6.4.2 Modification of Stock Options During Blackout Periods 296
6.5 Equity Restructuring 296
6.5.1 Antidilution Provisions 297
6.5.1.1 Original Award Contains a Nondiscretionary Antidilution Provision 297
6.5.1.2 Modification to Add a Nondiscretionary Antidilution Provision in Contemplation
of an Equity Restructuring 299
6.5.1.3 Modification to Add a Nondiscretionary Antidilution Provision That Is Not in
Contemplation of an Equity Restructuring 300
6.5.2 Spin-Offs 301
6.5.2.1 Attribution of Compensation Cost in a Spin-Off 301
6.5.2.2 Classification of Awards in a Spin-Off 302
6.5.2.3 Determining the Market Price Before and After a Spin-Off 302
6.5.3 Accounting for Awards Modified in Conjunction With an Equity Restructuring Held by
Individuals No Longer Employed or Providing Goods or Services 303
6.6 Business Combination 303
6.7 Short-Term Inducements 304
6.8 Modifications That Result in a Change in Classification 305
6.8.1 Modification From an Equity Award to a Liability Award 305
6.8.2 Modification From a Liability Award to an Equity Award 311
6.9 Modifications Under ASR 268 315
6.10 Repurchases and Settlements 319
6.10.1 Cash Settlements 320
6.10.2 Cash Settlements Versus Modifications 324
6.11 Cancellations 328
6.12 Modifications That Change the Scope of Awards 330
6.13 Modifications When a Holder Is No Longer an Employee, a Nonemployee Is No Longer
Providing Goods or Services, or a Grantee Is No Longer a Customer 331
Chapter 7 — Liability-Classified Awards 334

7.1 Fair-Value-Based Measurement 334
7.2 Recognition 336
7.2.1 Cash-Settled SARs 336
7.2.2 Liability-Classified Awards With Market Conditions 339
7.3 Intrinsic-Value Practical Expedient for Nonpublic Entities 340
7.4 Modifications 342
ix
Chapter 8 — Employee Stock Purchase Plans 345

8.1 Scope 345
8.2 Noncompensatory Plans 346
8.2.1 First Condition in ASC 718-50-25-1 346
8.2.2 Second Condition in ASC 718-50-25-1 348
8.2.3 Third Condition in ASC 718-50-25-1 349
8.3 Requisite Service Period 349
8.4 Forfeitures 352
8.5 Measurement 353
8.6 Changes in Employee Withholdings 353
8.6.1 Increase in Withholdings 354
8.6.2 Decrease in Withholdings 354
8.7 Look-Back Plans 355
8.7.1 Basic Look-Back Plans 357
8.7.2 Variable Versus Maximum Number of Shares 360
8.7.3 Multiple Purchase Periods 362
8.7.4 Reset or Rollover Mechanisms 362
8.7.5 Retroactive Cash Infusion Election 364
Chapter 9 — Nonemployee Awards 365

9.1 Overview 365
9.2 Scope 366
9.2.1 Sales Incentives to Customers 368
9.3 Recognition 368
9.3.1 Attribution of Cost 371
9.3.1.1 Recognition as if Cash Were Paid 371
9.3.1.2 Graded Vesting Awards 371
9.3.2 Vesting Conditions 371
9.3.2.1 Service Condition 372
9.3.2.2 Performance Condition 373
9.4 Measurement 375
9.4.1 Contractual Term Versus Expected Term 376
9.4.2 Practical Expedients for Nonpublic Entities 376
9.4.2.1 Expected Term 377
9.4.2.2 Calculated Value 378
9.4.2.3 Intrinsic Value 379
9.6 Nonemployee Awards Exchanged in a Business Combination 384
9.7 Presentation 387
9.8 Disclosures 389
9.9 Nonemployees of an Equity Method Investee 389
x
Contents
Chapter 10 — Business Combinations 393

10.1 Replacement of Acquiree Awards 393
10.2 Allocating Replacement Awards Between Consideration Transferred and Postcombination
Compensation Cost 394
10.2.1 Allocation Steps 401
10.2.1.1 Considerations Related to Step 1 402
10.2.2 Forfeitures 405
10.2.3 Employee Awards With a Graded Vesting Schedule 406
10.3 Changes Reflected in Postcombination Compensation Cost 408
10.3.1 Changes in Forfeiture Estimates or Actual Forfeitures in the Postcombination Period 409
10.3.2 Changes in the Probability of Meeting a Performance Condition in the
Postcombination Period 417
10.4 Acceleration of Vesting Upon a Change in Control 420
10.4.1 Acquirer Accelerates Vesting 420
10.4.2 Acceleration of Vesting Included in the Original Terms of the Awards 421
10.4.3 Modification to the Original Terms of the Awards to Add a Change-in-Control Provision
in Contemplation of a Business Combination 422
10.5 Cash Settlement Upon a Change in Control 423
10.5.1 Acquirer Cash Settles the Acquiree’s Awards (Cash-Settlement Provision Is Not
Included in the Original Terms of the Award) 424
10.5.1.1 Fully Vested Awards That Are Cash Settled Upon a Change in Control 424
10.5.1.2 Partially Vested Awards That Are Cash Settled Upon a Change in Control 424
10.5.2 Cash-Settlement Provision Is Included in the Original Terms of the Award 424
10.5.2.1 Fully Vested Awards That Are Cash Settled Upon a Change in Control 425
10.5.2.2 Partially Vested Awards That Are Cash Settled Upon a Change in Control 425
10.6 Arrangements for Contingent Payments to Employees or Selling Shareholders 426
10.7 Compensation Arrangements 427
10.7.1 Arrangements to Pay an Acquiree’s Employee Upon a Change in Control 427
10.7.2 Dual- or Double-Trigger Arrangements 428
10.7.3 Arrangements to Reallocate Forfeited Awards or Amounts to Remaining
Shareholders/Employees 429
10.8 Tax Effects of Replacement Awards Issued in a Business Combination 430
Chapter 11 — Income Tax Accounting 431
Chapter 12 — Presentation 433

12.1 Statement of Financial Position 433
12.1.1 Receivables 433
12.1.2 Deferred Tax Assets 434
12.1.3 Capitalization of Inventory 435
12.1.4 Fully Vested Nonemployee Awards 435
12.1.5 Presentation of Awards With Repurchase Features That Function as Vesting Conditions 435
xi
12.2 Statement of Operations 436

12.2.1 Classification of Compensation Expense 436
12.2.2 Share-Based Payment Awards Granted to Employees and Nonemployees of an
Equity Method Investee 437
12.2.3 Nonemployee Awards Issued in Exchange for Goods or Services 438
12.2.4 Payroll Taxes 438
12.3 Statement of Cash Flows 438
12.4 Earnings per Share 439
12.4.1 Basic EPS 440
12.4.2 Diluted EPS 440
12.4.2.1 Treasury Stock Method 443
12.4.2.2 Service Conditions 454
12.4.2.3 Performance and Market Conditions 455
12.4.3 Participating Securities and the Two-Class Method 460
12.4.3.1 Participating Securities 463
12.4.3.2 Computation Under the Two-Class Method 465
12.4.4 Settlement in Shares or Cash 478
12.4.5 Early Exercise of Stock Options 482
12.4.5.1 Basic EPS 482
12.4.5.2 Diluted EPS 483
12.4.6 Employee Stock Purchase Plans 483
12.4.6.1 General 483
12.4.6.2 Withholdings Are Not Refundable 483
12.4.6.3 Withholdings Are Refundable 484
12.4.7 Redeemable Awards 488
12.4.7.1 Share-Based Payment Awards Redeemable at Fair Value 489
12.4.7.2 Share-Based Payment Awards Redeemable at an Amount Other Than Fair Value 489
12.4.7.3 Share-Based Payment Awards Redeemable at Intrinsic Value 489
12.4.7.4 Contingently Redeemable Share-Based Payment Awards 490
12.4.8 Awards of a Consolidated Subsidiary 490
12.4.8.1 Share-Based Payment Awards Issued by a Consolidated Subsidiary and Settled
in the Subsidiary’s Common Shares 490
12.4.8.2 Share-Based Payment Awards Issued by a Subsidiary but Settled in the
Parent’s Common Shares 494
xii
Contents
Chapter 13 — Disclosure 495

13.1 Disclosure Objective 495
13.2 Minimum Disclosures 495
13.3 Examples of Required Disclosures 498
13.4 Interim Reporting 502
13.5 Subsidiary Disclosures 503
13.6 Nonemployee Awards 504
13.7 Change in Valuation Techniques 504
13.8 Transition From Nonpublic to Public Entity Status 505
13.9 MD&A Disclosures — Expected Volatility 508
Chapter 14 — Accounting for Share-Based Payments Issued as Sales Incentives to

Customers 509
14.1 Background 509
14.2 Overview 509
14.3 Scope 509
14.4 Initial Measurement 511
14.6 Subsequent Measurement and Presentation 514
14.6.1 Equity-Classified Share-Based Payments 515
14.6.2 Liability-Classified Share-Based Payments 517
14.6.3 Practical Expedients for Nonpublic Entities 517
14.7 Recognition 518
14.8 Disclosure 519
Appendix A — Comparison of U.S. GAAP and IFRS Standards 520
Appendix B — Titles of Standards and Other Literature 526
Appendix C — Abbreviations 530
Appendix D — Roadmap Updates for 2021 531
xiii
Preface
We are pleased to present the 2021 edition of Share-Based Payment Awards. This Roadmap provides
Deloitte’s insights into and interpretations of the guidance on share-based payment arrangements in
ASC 7181 (employee and nonemployee awards) as well as in other literature (e.g., ASC 260 and ASC 805).
Updates in the 2021 edition include those discussed below as well as On the Radar, a new section that
briefly summarizes emerging issues and trends related to the accounting and financial reporting topics
addressed in the Roadmap. Appendix D notes the significant changes made since the issuance of the
2020 edition of this publication.
In June 2018 the FASB issued ASU 2018-07, which simplifies the accounting for share-based payments
granted to nonemployees for goods and services. ASU 2018-07 aligns most of the guidance on
nonemployee share-based payment awards with the requirements for employee share-based payment
awards. Before adopting ASU 2018-07, entities used ASC 505-50 to account for share-based payment
awards issued to nonemployees in exchange for goods or services. Accordingly, the ASU supersedes
ASC 505-50 and expands the scope of ASC 718 to include all share-based payment arrangements
related to the acquisition of goods and services from both nonemployees and employees.
It is assumed in this Roadmap that an entity has adopted ASU 2018-07. The changes to the accounting
framework introduced by ASU 2018-07 are reflected throughout the Roadmap to align with the revised
terminology and definitions in ASC 718. Chapter 9 addresses the accounting for nonemployee awards
to the extent that it is different from the accounting for employee awards discussed throughout the
Roadmap.
It is also assumed in the Roadmap that an entity has adopted ASU 2019-08, which clarifies the
accounting for share-based payments issued as consideration payable to a customer under ASC 606.
Under the ASU, entities apply the guidance in ASC 718 to measure and classify share-based payments
issued to a customer that are not in exchange for a distinct good or service (i.e., share-based sales
incentives). See Chapter 14 for a detailed discussion of such arrangements.
In October 2021, the FASB issued ASU 2021-07, which allows nonpublic entities to use, as a practical
expedient, “the reasonable application of a reasonable valuation method” to determine the current price
input of equity-classified share-based payment awards issued to both employees and nonemployees.
Other than the discussion in Section 4.13.1, the guidance in the Roadmap has not been updated to
reflect ASU 2021-07.
Note that this publication is not a substitute for the exercise of professional judgment, which is often
essential to applying the accounting requirements for share-based payment awards. It is also not a
substitute for consulting with Deloitte professionals on complex accounting questions and transactions.
1
For the full titles of standards, topics, regulations, and abbreviations used in this publication, see Appendixes B and C. Note that this Roadmap
does not cover the guidance on employee stock ownership plans in ASC 718-40.
xiv
Preface
Subscribers to the Deloitte Accounting Research Tool (DART) may access any interim updates to
this publication by selecting the Roadmap from the Roadmap Series page on DART. If a “Summary
of Changes Since Issuance” displays, subscribers can view those changes by clicking the related links
or by opening the “active” version of the Roadmap.
We hope that you find this publication a valuable resource when considering the accounting guidance
on share-based payment arrangements.
xv
On the Radar
To incentivize employee performance and align the interests of employees and shareholders, entities
often grant share-based payment awards — including stock options, restricted stock, restricted stock
units, stock appreciation rights, and other equity-based instruments — in exchange for services. To a
lesser extent, entities also grant such awards to compensate vendors for goods and services or as sales
incentives to customers.
ASC 718 provides the accounting guidance on share-based payment awards, which requires entities to
use a fair-value-based measure when recognizing the cost associated with these awards in the financial
statements. Some of the more challenging aspects of applying this guidance are highlighted below.
Scope
An entity must first determine whether an award is within the scope of ASC 718 or is, in substance, a
bonus or profit-sharing arrangement. ASC 718 applies to awards that must be settled in the equity of
the entity or whose settlement is based, at least in part, on the price of the entity’s equity. An entity’s
conclusion related to whether an award is within the scope of ASC 718 can significantly affect the
amount of compensation cost recognized and when such cost is recognized in the financial statements.
Nonpublic limited partnerships or limited liability companies often establish special classes of equity,
referred to as profits interests. These special equity classes often have distribution thresholds or hurdles
related to amounts that must be paid to other classes of equity before the grantee of the profits interest
can receive distributions. On the grant date, an award may have zero liquidation value for tax purposes
but a fair value for financial reporting purposes.
While the features of a profits interest award can vary, such an award should be accounted for on
the basis of its substance. If the award has the characteristics of an equity interest, it represents a
“substantive class of equity” and should be accounted for under ASC 718. However, an award that is, in
substance, a performance bonus or a profit-sharing arrangement would be accounted for as such in
accordance with other U.S. GAAP (e.g., typically ASC 710 for employee arrangements).
There are several characteristics to consider when determining whether an instrument is within the
scope of ASC 718. To be a substantive class of equity, the profits interest must be legal form equity. An
entity would also consider whether the instrument’s holder can retain a vested interest in an award if
the holder stops providing goods or services to the company. In determining whether a repurchase
feature allows the grantee to retain a vested interest, an entity would assess whether the repurchase
price of that repurchase feature is consistent with the fair value of the award. Other characteristics of
the award (e.g., claim to residual assets of the entity upon liquidation, substantive net assets underlying
the interest, and distribution rights after vesting) could also be relevant to the entity’s conclusion.
xvi
On the Radar
Classification
If an entity concludes that an award is within the scope of ASC 718, it must then determine whether
that award will be recognized within equity or as a liability. An award’s classification as either equity
or a liability can significantly affect the amount of compensation cost an entity recognizes for it.
Equity-classified awards are generally measured as of the grant date and, in the absence of any
modifications, the total amount of compensation cost to be recognized is fixed at the grant-date
measurement amount. By contrast, liability-classified awards must be remeasured to fair value as of
every reporting period until settled. Accordingly, if the value of an entity’s shares increases before the
liability is settled, the total recognized compensation cost of a liability-classified award will also increase.
Determining the classification of a share-based payment award can be challenging. While classifying
a cash-settled award as a liability may seem straightforward, other awards may contain features and
conditions that entities must analyze further. Examples of questions to consider in the determination of
the classification of an award include the following:
▪ Can the grantee of the award choose the method of settlement (i.e., shares or cash)?
▪ Can the entity be forced to settle the award in cash or other assets of the entity?
▪ Does the entity have a past practice of settling the award in cash even though the written terms of the
Examples of questions
award state that it will be settled in shares of the entity?

▪ Does the award specify a fixed dollar amount that is settled in a variable number of shares of the entity?
▪ Is the award indexed to something other than a service, market, or performance condition?
▪ Do the awards include repurchase features (i.e., grantee put rights and entity call rights)?
▫ Can the repurchase feature be exercised immediately upon vesting?
▫ Is the repurchase price an amount other than the fair value of the award on the purchase date (i.e.,
fixed price or formula price)?
▫ Is the exercise of the repurchase feature contingent on a specified event?
▪ Is the underlying share of an option award classified as a liability?
Some of these questions typically only pertain to nonpublic entities. For example, nonpublic entities
often include repurchase features to remain closely held or may choose to settle the award in cash to
provide liquidity to the grantee for shares that are not actively traded.
Secondary Transactions
When a nonpublic entity repurchases common shares from its employees at an amount greater than
the estimated fair value of the shares at the time of the transaction, the excess of the purchase price
over the fair value of the common shares generally represents employee compensation. In addition,
investors (e.g., private equity or venture capital investors) may purchase shares held by current or
former employees of an entity because such investors want to acquire or increase their stake in that
entity or provide liquidity to the entity’s employees. An entity must first establish whether the price
paid by the investors is greater than the fair value of the purchased shares. Any consideration paid in
excess of the fair value of the shares is presumed to be compensation cost and an in-substance equity
contribution that must be recognized by the reporting entity.
For example, in connection with a convertible preferred stock financing, an entity may arrange for
investors to purchase common stock from employees by using the price established for the convertible
preferred stock. Typically, the value of preferred shares will exceed the value of common shares
(assuming one-to-one conversion) because of preferential rights normally associated with preferred
shares. The price paid in excess of the fair value is recognized as compensation cost.
xvii
While purchases of shares from current and former employees often result in compensation, there
are circumstances in which a secondary market transaction between an investor and a nonpublic
entity’s employees represents an orderly arm’s-length transaction at fair value. In such cases, the
nonpublic entity has adequate support for a conclusion that the transaction was measured at fair value
and therefore did not result in additional compensation cost. If the nonpublic entity can support a
conclusion that the stock repurchase transaction was measured at fair value and was not compensatory,
the entity would typically take the transaction into account when valuing its common stock, which a
third-party valuation firm typically performs to ensure compliance with IRC Section 409A and determine
the fair-value-based measure of the nonpublic entity’s share-based payment arrangements.
Cheap Stock
As an entity prepares for an IPO, the SEC staff often focuses on “cheap stock”1 issues. The staff is
interested in the rationale for any difference between the fair value measurements of the underlying
common stock of share-based payment awards issued within the past year and the anticipated IPO
price. In addition, the staff will challenge valuations that are significantly lower than prices paid by
investors in recent acquisitions of similar stock. If the differences cannot be reconciled, a nonpublic
entity may be required to record a cheap-stock charge. Such a charge could be material and, in some
cases, lead to a restatement of the financial statements.
Waiting to consider cheap stock issues until after the SEC raises related questions may
delay a declaration that an IPO registration statement is effective.
When the estimated fair value of an entity’s stock is significantly below the anticipated IPO price, the
entity should be able to reconcile the change in the estimated fair value of the underlying equity
between the award grant date and the IPO. To perform this reconciliation, the entity would take into
account, among other things, intervening events and changes in assumptions that justify the change
in fair value. The SEC staff has frequently inquired about a registrant’s pre-IPO valuations. Specifically,
during the registration statement process, the SEC staff may ask an entity to (1) reconcile its recent fair
value measurements with the anticipated IPO price; (2) describe its valuation methods; (3) justify its
significant valuation assumptions, including the weight given to operating the business both under and
in the absence of an IPO; (4) outline significant intervening events; and (5) discuss the weight it gives to
stock sale transactions.
1
Cheap stock refers to issuances of equity securities before an IPO in which the value of the shares is below the IPO price.
xviii
Contacts
If you have questions about the information in this publication, please contact:
Sean May Ashley Carpenter

Partner Partner
Deloitte & Touche LLP Deloitte & Touche LLP
+1 415 783 6930 +1 203 761 3197
[email protected] [email protected]
Mark Crowley Jamie Davis

Managing Director Partner
+1 203 563 2518 +1 312 486 0303
Sandie Kim Ignacio Perez

Partner Managing Director
+1 415 783 4848 +1 203 761 3379
Aaron Shaw Stefanie Tamulis

Partner Managing Director
+1 202 220 2122 +1 203 563 2648
xix
If you are interested in Deloitte’s share-based payment service offerings, please contact:
Steve Barta
Partner
Deloitte & Touche LLP
+1 415 783 6392
[email protected]
xx
Chapter 1 — Overview
1.1 Objective
ASC 718-10
10-1 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.
10-2 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.
To incentivize employee and nonemployee performance and align the interests of grantees and
shareholders, entities often grant share-based payment awards such as stock options, restricted stock,1
restricted stock units (RSUs), stock appreciation rights (SARs), and other equity-based instruments
in exchange for goods or services or consideration paid to a customer. Such awards are a form of
compensation. One of ASC 718’s objectives is for entities to recognize the cost of that compensation in
their financial statements as the goods or services associated with the awards are provided. The amount
of cost to recognize is generally based on the fair value of the share-based payment arrangement, and
ASC 718 requires entities to apply a “fair-value-based measurement method” when accounting for such
arrangements.2
1.2 Substantive Terms
ASC 718-10 — Glossary
Terms of a Share-Based Payment Award

The contractual provisions that determine the nature and scope of a share-based payment award. For
example, the exercise price of share options is one of the terms of an award of share options. As indicated
in paragraph 718-10-25-15, the written terms of a share-based payment award and its related arrangement,
if any, usually provide the best evidence of its terms. However, an entity’s past practice or other factors may
indicate that some aspects of the substantive terms differ from the written terms. The substantive terms of
a share-based payment award, as those terms are mutually understood by the entity and a party (either an
employee or a nonemployee) who receives the award, provide the basis for determining the rights conveyed
to a party and the obligations imposed on the issuer, regardless of how the award and related arrangement, if
any, are structured. See paragraph 718-10-30-5.
1
ASC 718 refers to restricted stock (and RSUs) as nonvested shares (and nonvested share units). See Sections 3.3, 4.7, and 4.8 for a discussion of
the differences between a nonvested share and a restricted share.
2
See Sections 1.7 and 4.13 for a discussion of exceptions for nonpublic entities to the fair-value-based measurement requirement.
1
ASC 718-10
25-3 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.
25-4 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.
It is important for an entity to consider all of an award’s terms when evaluating a share-based payment
arrangement. While the written plan and agreement are generally the best evidence of the award’s
terms, an entity’s past practice or other factors may indicate that the substantive terms differ from the
written ones. For example, if an entity’s award agreement indicates that the award will be settled in
shares of the entity’s stock, but the entity has made an oral promise to settle the award in cash or has
a past practice of settling awards in cash, the substantive terms of the award would indicate that there
is a cash settlement feature. The substantive terms that are mutually understood by the entity and the
grantee provide the basis for determining the accounting irrespective of how the award and related
agreements may be drafted or structured. This concept is illustrated in ASC 718-10-25-3, which indicates
that a nonrecourse note received by an entity as consideration for the issuance of stock is, in substance,
the same as the grant of stock options and therefore should be accounted for as a substantive grant of
stock options. Another example of this concept is a feature that allows an entity to repurchase “vested”
shares awarded in a share-based payment arrangement for no consideration if the grantee ceases
providing goods or services before four years after the grant date of the awards. In this scenario, the
repurchase feature functions, in substance, as a vesting condition.
1.3 Scope
ASC 718 generally applies to share-based payments granted to (1) employees or nonemployees in
exchange for goods or services to be used or consumed in the grantor’s own operations or (2) customers
of the entity.3 Further, such payments must be either (1) settled by issuing the entity’s equity shares or
other equity instruments or (2) indexed, at least in part, to the value of the entity’s equity shares or other
equity instruments. See Chapter 2 for a more detailed discussion of the scope of ASC 718.
To determine whether ASC 718 applies, an entity should evaluate transactions between (1) grantees that
provide goods and services or grantees that are customers and (2) related parties or other economic
interest holders of the entity. If a transaction is deemed to be compensation for goods or services or
if the transaction provides consideration to a customer that is not in exchange for a good or service,
it is accounted for as a capital contribution to the entity and as a share-based payment arrangement
between the entity and the grantee. See Section 2.4 for additional guidance.
3
Share-based payments granted to employees or nonemployees in exchange for goods or services are discussed throughout this Roadmap. Share-
based payments issued as consideration payable to a customer are discussed in Chapter 14.
2
1.4 Recognition
ASC 718 requires compensation cost to be recognized over the employee’s requisite service period or
the nonemployee’s vesting period. The requisite service period is the period during which the employee
is required to provide services to earn the share-based payment award. The nonemployee’s vesting
period is the period over which the cost of a nonemployee share-based payment award is recognized
(i.e., the period the goods or services are provided). The service inception date, which is generally
the grant date, is the beginning of the requisite service period or the nonemployee’s vesting period.
Therefore, the service inception date is the date on which an entity begins to recognize compensation
cost related to the share-based payments. For awards with only a service condition, the vesting period
is generally the requisite service period or the nonemployee’s vesting period unless there are other
substantive terms to the contrary. However, for nonemployee share-based payment awards, an entity
should recognize compensation cost “when it obtains the goods or as services are received” and “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.” This is referred to within ASC 718 and this
Roadmap as the “nonemployee’s vesting period.”
An employee’s requisite service period4 can be explicit, implicit, or derived, depending on the award’s
terms and conditions:
• An explicit service period is stated in the terms of an award. For example, if the award vests after
four years of continuous service, the explicit service period is four years.
• An implicit service period is not explicitly stated in the terms of the award but may be inferred
from an analysis of those terms and other facts and circumstances that are typically associated
with a performance condition. For example, if an award vests only upon the completion of a new
product design and the design is expected to be completed two years from the grant date, the
implicit service period is two years.
• A derived service period is inferred from the application of certain techniques used to value an
award with a market condition. For example, if an award becomes exercisable when the market
price of the entity’s stock reaches a specified level, and that specified level is expected to be
achieved in three years (as inferred from the valuation technique), the derived service period is
three years.
An award may contain more than one explicit, implicit, or derived service period (i.e., multiple
conditions). However, it can have only one requisite service period, with the exception of a graded
vesting award that is accounted for, in substance, as multiple awards; see Section 3.6.5. If an award
contains multiple conditions, an entity may need to take into account the interrelationship of those
conditions. Further, the entity must make an initial best estimate of the requisite service period as of the
grant date, and it should revise that estimate as facts and circumstances change. Section 3.8 discusses
how to account for a change in the estimated requisite service period.
Compensation cost is based on the number of awards that vest, which generally depends on satisfaction
of the awards’ service conditions, performance conditions,5 or both. For service conditions, an entity
can, separately for employee awards and nonemployee awards, make an entity-wide accounting policy
election to either (1) estimate the total number of awards for which the good will not be delivered or the
service will not be rendered (i.e., estimate the forfeitures expected to occur) or (2) account for forfeitures
4
Determining the requisite service period is only applicable to employee awards. However, for certain nonemployee awards, an entity may
analogize to the guidance on calculating a requisite service period and determining the service inception date when such guidance is relevant to
the accounting for the nonemployee award. For additional discussion of a nonemployee’s vesting period, see Section 9.3.2.
5
There may be certain situations in which a service or performance condition does not affect the number of awards that vest and instead affects
factors other than vesting, such as the exercise price or conversion ratio.
3
when they occur. If the entity elects the first option, it will estimate the likelihood that employees will
terminate employment or nonemployees will cease providing goods or services before satisfying the
service condition and factor this forfeiture estimate into the amount of compensation cost accrued (i.e.,
decrease the quantity of awards). It will then adjust the estimated quantity if facts and circumstances
change so that the total amount of compensation cost recognized at the end of the employee’s requisite
service period or the nonemployee’s vesting period is based on the number of awards for which the
employee’s requisite service is rendered or the nonemployee’s goods or services are provided. If the
entity elects the second option, it will reverse previously recognized compensation cost when a grantee
forfeits the award by terminating employment (for employee awards) or ceasing to provide goods or
services (for nonemployee awards) before the grantee has satisfied the service condition.
For awards with performance conditions, an entity will need to assess the probability of meeting the
performance condition and will only recognize compensation cost if it is probable that the performance
condition will be met. The total compensation cost recognized will ultimately be based on the outcome
of the performance condition.
If a grantee forfeits an award that contains a market condition because of failure to meet the market
condition but delivers the promised good or renders the requisite service, compensation cost previously
recognized is not reversed. Compensation cost is only reversed if the grantee does not deliver the
promised good or render the requisite service, because a market condition is not considered a vesting
condition. In determining the fair-value-based measurement of the award, an entity takes into account
the likelihood that it will meet the market condition.
See Sections 3.4 and 3.5 for additional information about service, performance, and market conditions,
and see Chapter 3 for detailed guidance on the recognition of compensation cost.
1.5 Measurement
Share-based payment transactions are measured on the basis of the fair value (or in certain situations,
the calculated value or intrinsic value) of the equity instrument issued. As noted in Section 1.1, ASC
718 refers to a “fair-value-based” method for measuring the value of the share-based payment.
Conceptually, the fair value determined under this method is not fair value as defined in ASC 820, which
explicitly excludes share-based payments from its scope. Although fair value measurement techniques
are used in the fair-value-based measurement method, it specifically excludes the effects of vesting
conditions and other types of features (e.g., clawback provisions) that would be included in a fair value
measurement that is based on ASC 820. Therefore, when the term “fair value” is used in ASC 718
and in this Roadmap, it refers to a fair-value-based measurement determined in accordance with the
requirements of ASC 718.
For equity-classified awards, compensation cost is recognized over the employee’s requisite service period
or the nonemployee’s vesting period on the basis of the fair-value-based measure of the awards on the
grant date. The measurement of such awards is generally fixed on the grant date. By contrast, liability-
classified awards are remeasured at their fair-value-based measurement as of each reporting date until
settlement. That is, changes in the fair-value-based measure of the liability at the end of each reporting
period are recognized as compensation cost, either (1) immediately or (2) over the employee’s requisite
service period or the nonemployee’s vesting period. The total compensation cost ultimately recognized
for liability-classified awards on the settlement date will generally equal the settlement amount (e.g., the
amount of cash paid to settle the award).
Nonpublic entities can use certain practical expedients as a substitute for a fair-value-based
measurement. See further discussion in Section 1.7. See Chapter 4 for additional guidance on the
measurement of share-based payment awards.
4
1.6 Classification
As described above, an entity’s measurement of compensation cost differs depending on whether
the entity has determined that share-based payment awards are classified as equity or liabilities. An
overarching principle in ASC 718 is that a share-based payment arrangement cannot be classified as
equity unless the grantee is subject to the risks and rewards associated with equity share ownership
for a reasonable period. Any terms and conditions that could result in cash settlement, settlement in
other assets, or settlement in a variable number of shares should be carefully evaluated. In addition,
indexation of share-based payments to a factor other than a service, performance, or market condition
could result in liability classification. Further, all of an award’s substantive terms and conditions, as well
as an entity’s past practices, should be assessed in the determination of whether the entity has the
intent and ability to settle in shares. See Chapter 5 for a more detailed discussion of the classification of
awards as either liabilities or equity.
1.7 Nonpublic Entities
Nonpublic Entity
Any entity other than one that meets any of the following criteria:
a. Has equity securities that trade in a public market either on a stock exchange (domestic or foreign) or in
an over-the-counter market, including securities quoted only locally or regionally
b. Makes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a
public market
c. Is controlled by an entity covered by the preceding criteria.
An entity that has only debt securities trading in a public market (or that has made a filing with a regulatory
agency in preparation to trade only debt securities) is a nonpublic entity.
Public Business Entity

A public business entity is a business entity meeting any one of the criteria below. Neither a not-for-profit entity
nor an employee benefit plan is a business entity.
a. It is required by the U.S. Securities and Exchange Commission (SEC) to file or furnish financial
statements, or does file or furnish financial statements (including voluntary filers), with the SEC (including
other entities whose financial statements or financial information are required to be or are included in a
filing).
b. It is required by the Securities Exchange Act of 1934 (the Act), as amended, or rules or regulations
promulgated under the Act, to file or furnish financial statements with a regulatory agency other than
the SEC.
c. It is required to file or furnish financial statements with a foreign or domestic regulatory agency in
preparation for the sale of or for purposes of issuing securities that are not subject to contractual
restrictions on transfer.
d. It has issued, or is a conduit bond obligor for, securities that are traded, listed, or quoted on an
exchange or an over-the-counter market.
e. It has one or more securities that are not subject to contractual restrictions on transfer, and it is
required by law, contract, or regulation to prepare U.S. GAAP financial statements (including notes) and
make them publicly available on a periodic basis (for example, interim or annual periods). An entity must
meet both of these conditions to meet this criterion.
An entity may meet the definition of a public business entity solely because its financial statements or financial
information is included in another entity’s filing with the SEC. In that case, the entity is only a public business
entity for purposes of financial statements that are filed or furnished with the SEC.
5
ASC 718-10 — Glossary (continued)
Public Entity
An entity that meets any of the following criteria:
a. Has equity securities that trade in a public market, either on a stock exchange (domestic or foreign) or in
an over-the-counter market, including securities quoted only locally or regionally
b. Makes a filing with a regulatory agency in preparation for the sale of any class of equity securities in a
public market
c. Is controlled by an entity covered by the preceding criteria. That is, a subsidiary of a public entity is itself
a public entity.
An entity that has only debt securities trading in a public market (or that has made a filing with a regulatory
agency in preparation to trade only debt securities) is not a public entity.
Several practical expedients are available only to entities that meet the definition of a nonpublic entity
in ASC 718. In determining whether it qualifies as a nonpublic entity and can therefore apply the
practical expedients, an entity should note that the definition of a public entity is not the same as that
of a public business entity, which is separately defined in ASC 718. While an entity uses the definitions
of a public entity and a nonpublic entity to apply most of the guidance in ASC 718, it may also need to
determine whether it meets the definition of a public business entity when adopting a new standard’s
requirements.
1.7.1 Calculated Value
If a nonpublic entity cannot reasonably estimate the fair-value-based measure of its options and similar
instruments because estimating the expected volatility of its stock price is not practicable, it should use
the historical volatility of an appropriate industry sector index to calculate the value of the awards. The
resulting value is referred to as calculated value. See Section 4.13.2.
1.7.2 Intrinsic Value
For liability-classified awards, a nonpublic entity can elect as an accounting policy to measure all of its
liability-classified awards at either their intrinsic value or their fair-value-based measure. See Section
4.13.3 for additional information.
1.7.3 Expected Term
A nonpublic entity can elect, as an entity-wide accounting policy, to use a practical expedient in
estimating the expected term of certain options and similar instruments. That practical expedient can
only be used for awards that meet certain conditions. See Sections 4.9.2.2.3 and 4.13.1.2 for additional
information.
1.7.4 Transition to Public Entity

A nonpublic entity that becomes a public entity can no longer use the practical expedients that are
available to nonpublic entities, including calculated value and intrinsic value since public entities must
use a fair-value-based measurement. In addition, the practical expedient used by nonpublic entities to
determine the expected term of certain options and similar instruments is different from that used by
public entities. See Section 4.13.4 for more information.
6
1.8 Comparison With IFRS Standards

ASC 718 is the primary source of guidance in U.S. GAAP on the accounting for employee and
nonemployee share-based payment awards. IFRS 2 is the primary source of guidance on such awards
under IFRS Standards. Although much of the U.S. GAAP guidance is converged with that in IFRS 2, there
are some notable differences. See Appendix A for a discussion of those differences.
7
Chapter 2 — Scope
2.1 General
ASC 718-10
Overall Guidance
15-1 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.
Entities
15-2 The guidance in the Compensation — Stock Compensation Topic applies to all entities that enter into
share-based payment transactions.
15-3 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 employee or 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.
15-3A Paragraphs 323-10-25-3 through 25-5 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.
15-5 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 815-40-35-14 through
35-15, 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. Subparagraph superseded by Accounting Standards Update No. 2018-07.
b. Subparagraph superseded by Accounting Standards Update No. 2019-08.
c. Subparagraph superseded by Accounting Standards Update No. 2019-08.
8
Chapter 2 — Scope
ASC 718-10 (continued)
15-5A 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.
15-6 Paragraphs 805-30-30-9 through 30-13 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.
15-7 The guidance in the Overall Subtopic does not apply to equity instruments held by an employee stock
ownership plan.
ASC 718 applies to all transactions in which an entity receives goods or services to be used or consumed
in the entity’s own operations in exchange for share-based instruments. In such transactions, an entity
effectively “pays” grantees in the form of share-based instruments for goods or services. Common
examples of share-based payment awards include stock options, SARs, restricted stock,1 and RSUs.
In addition, entities must apply ASC 718 to measure and classify share-based payments that are
issued as consideration payable to a customer and are not in exchange for distinct goods or services
(i.e., share-based sales incentives). Because entities are also required to recognize share-based sales
incentives in accordance with ASC 606, the accounting for such awards is unique. See Chapter 14 for
additional information.
ASC 718 does not apply to share-based instruments issued in exchange for cash or other assets (i.e.,
detachable warrants or similar instruments issued in a financing transaction) because such instruments
are not issued in exchange for goods or services. Other share-based transactions, or aspects of these
transactions, that are not within the scope of ASC 7182 include:
• Equity instruments issued as consideration in a business combination — ASC 718 does not address
the accounting for equity instruments issued as consideration in a business combination. The
measurement date for such equity instruments is described in ASC 805-30-30-7.
ASC 805 also provides guidance on determining what portion of share-based payment awards
exchanged in a business combination is (1) part of the consideration transferred in a business
combination or (2) related to service to be recognized in the postcombination period and
therefore is within the scope of ASC 718. ASC 805-20-30-21, ASC 805-30-30-9 through 30-13,
ASC 805-30-55-6 through 55-13, ASC 805-30-55-17 through 55-35, ASC 805-740-25-10 and 25-11,
and ASC 805-740-45-5 and 45-6 provide guidance on share-based payment awards exchanged
in connection with a business combination. See Chapter 10 for additional information.
• Options or warrants issued for cash or other than for goods or services — Financial instruments
issued for cash or other financial instruments (i.e., other than for goods or services) are
accounted for in accordance with the relevant literature on accounting for and reporting the
issuance of financial instruments, such as ASC 815 and ASC 480.
1
ASC 718 refers to restricted stock (and RSUs) as nonvested shares (and nonvested share units).
2
Employee stock ownership plans (ESOPs) are within the scope of ASC 718-40 and are not covered in this Roadmap. ASC 718-10-20 defines an
ESOP as “an employee benefit plan that is described by the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code of
1986 as a stock bonus plan, or combination stock bonus and money purchase pension plan, designed to invest primarily in employer stock. Also
called an employee share ownership plan.” Entities should continue to account for ESOPs in accordance with ASC 718-40 or SOP 76-3. Although
SOP 76-3 was not included in the Codification, entities may continue to apply it to shares acquired by ESOPs on or before December 31, 1992.
9
• Detachable options or warrants issued in a financing transaction — ASC 470-20 describes how
an entity should account for detachable warrants, or similar instruments, issued in a financing
transaction.
• Share-based awards that are granted to employees or nonemployees and settled in shares of
an unrelated entity — ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48 describe
the accounting for stock options that are issued to grantees and indexed to and settled in
publicly traded shares of an unrelated entity. See Section 2.11 for more information about the
accounting for awards that are issued to grantees and indexed to and settled in shares of an
unrelated entity.
Only share-based payment awards that are issued in exchange for goods or services or issued as
share-based sales incentives are within the scope of ASC 718. Further, such awards must be either
(1) settled by issuing the entity’s equity shares or other equity instruments or (2) indexed, at least in
part, to the value of the entity’s equity shares or other equity instruments. In this context, the word
“indexed” indicates that the value the grantee receives upon settlement of the award is, at least in part,
determined on the basis of the value of the entity’s equity. For instance, an entity may award a cash-
settled SAR that can only be settled in cash. In such circumstances, the amount of cash the grantee
receives upon settlement of the award is based on the relationship of the market price of the entity’s
equity shares to the exercise price of the award; therefore, the award is considered indexed to the
entity’s equity and is within the scope of ASC 718.
Example 2-1
Entity A, a public entity, offers a long-term incentive plan (LTIP) to certain of its employees. At the beginning
of each year, a target cash bonus based on a specific dollar amount is established for each employee. Each
employee in the LTIP will receive a predetermined percentage of his or her target bonus at the end of three
years on the basis of the total return on A’s stock price relative to that of its competitors over the three-year
performance period. The return on A’s stock price is ranked with that of its competitors from the highest to
the lowest performer. On the basis of A’s ranking, each employee will receive a percentage of his or her target
bonus that increases or decreases as A’s ranking increases or decreases.
For example, at the beginning of the three-year performance period, A sets a target cash bonus of $100,000
for an employee. Entity A includes nine of its competitors in its peer group to establish a ranking. Depending
on the ranking, the employee will receive a percentage that ranges from 0 percent to 200 percent of the target
bonus. For instance, if A ranks first in stock price return, the employee will receive 200 percent of $100,000, or
$200,000; if A ranks fifth, the employee will receive 100 percent of $100,000, or $100,000; and if A ranks tenth
or last, the employee will not receive a bonus.
Because the bonus is settled only in cash, A’s obligation under the LTIP is classified as a share-based liability.
The liability is based, in part, on the price of A’s shares. That is, the share-based liability is based on the return
on A’s stock price relative to the returns on the stock prices of A’s competitors. While the bonuses to be paid
are not linearly correlated to the return on A’s stock price, the amount of the bonus does depend on the return
on A’s stock price relative to that of its competitors. Accordingly, the LTIP is within the scope of, and therefore
is accounted for in accordance with, ASC 718. Under ASC 718-30-35-3, A “shall measure a liability award under
a share-based payment arrangement based on the award’s fair value remeasured at each reporting date until
the date of settlement.”
Informal discussions with the FASB staff support the conclusion that LTIPs can be within the scope of ASC 718.
If an award offers a grantee a fixed monetary amount that is settled in a variable number of an entity’s
shares, the amount the grantee receives upon settlement of the award is not based on the value of the
entity’s equity and therefore is not considered indexed to the entity’s own equity. However, the fixed
monetary amount will be settled by issuing a variable number of the entity’s shares. Because the award
is settled by issuing the entity’s own equity, the award is within the scope of ASC 718.
10
Chapter 2 — Scope
Example 2-2
An entity sets a bonus of $100,000 for its chief executive if the executive remains employed for a two-year
period. The bonus will be settled by issuing enough equity shares whose value equals $100,000. Therefore, if
the entity’s share price is $50 at the end of the second year, the entity will settle the bonus by issuing 2,000
($100,000 bonus ÷ $50 share price) of the entity’s equity shares. This bonus award is within the scope of ASC
718 because it is settled by issuing the entity’s own equity.
Share-based payment awards that are indexed to or settled in something other than an entity’s shares
may be within the scope of ASC 718. ASC 718-10-20 defines share-based payment arrangements, in
part, as follows:
The term shares [in ASC 718-10-15-3] includes various forms of ownership interest that may not take the
legal form of securities (for example, partnership interests), as well as other interests, including those that are
liabilities in substance but not in form. Equity shares refers only to shares that are accounted for as equity.
That is, the legal form of the entity’s award does not preclude it from being within the scope of ASC 718.
In this context, the term “shares” broadly represents instruments that entitle the holder to share in the
risks and rewards of the entity as an owner.
Example 2-3
Trust Unit Rights

An entity may grant its employees trust unit rights to purchase a unit in a unit investment trust at a reduced
exercise price. Upon exercise of the unit right, the holder receives publicly traded trust units, which are equal
fractional undivided interests in the trust. The trust units are the only voting, participating equity securities of
the trust. The trust structure is created to purchase and hold a fixed portfolio of securities or other assets,
which represent the “trust portfolio.” The trust then distributes the income generated from the portfolio to
the holders of the trust units. Therefore, owning a trust unit allows the holder to share in the appreciation of
the trust portfolio. Common examples of this type of investment trust structure include mutual funds and real
estate investment trusts.
While the entity is offering to issue unit rights, which are not legal securities themselves, the rights entitle the
holder to trust units. Although these trust units are not “shares” in the strictest sense, they provide the holder
with the risks and rewards of the entity as an owner (e.g., voting rights). Accordingly, this arrangement is within
the scope of ASC 718.
Example 2-4
Phantom Stock Plans

Under a typical phantom stock plan, an employee is granted a theoretical number of units that are exercisable
into common stock of the entity. These units are not legal securities themselves and usually are issued only on
a memorandum basis. The units do not have voting rights with the common stockholders. The value of each
phantom unit is based on the value of the entity’s stock and, therefore, appreciates and depreciates on the
basis of fluctuations in the value of the entity’s stock.
The phantom stock unit holders do not have the same rights as a common stockholder (i.e., voting rights).
However, because the phantom units are indexed to and settled in the entity’s equity, this arrangement is
within the scope of ASC 718.
11
2.2 Definition of Employee
Employee
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. A reporting entity
based in a foreign jurisdiction would determine whether an employee-employer relationship exists based on
the pertinent laws of that jurisdiction. Accordingly, a grantee meets the definition of an employee if the grantor
consistently represents that individual to be an employee under common law. The definition of an employee
for payroll tax purposes under the U.S. Internal Revenue Code includes common law employees. Accordingly,
a grantor that classifies a grantee potentially subject to U.S. payroll taxes as an employee also must represent
that individual as an employee for payroll tax purposes (unless the grantee is a leased employee as described
below). A grantee does not meet the definition of an employee solely because the grantor represents that
individual as an employee for some, but not all, purposes. For example, a requirement or decision to classify
a grantee as an employee for U.S. payroll tax purposes does not, by itself, indicate that the grantee is an
employee because the grantee also must be an employee of the grantor under common law.
A leased individual is deemed to be an employee of the lessee if all of the following requirements are met:
a. The leased individual qualifies as a common law employee of the lessee, and the lessor is contractually
required to remit payroll taxes on the compensation paid to the leased individual for the services
provided to the lessee.
b. The lessor and lessee agree in writing to all of the following conditions related to the leased individual:
1. The lessee has the exclusive right to grant stock compensation to the individual for the employee
service to the lessee.
2. The lessee has a right to hire, fire, and control the activities of the individual. (The lessor also may
have that right.)
3. The lessee has the exclusive right to determine the economic value of the services performed by the
individual (including wages and the number of units and value of stock compensation granted).
4. The individual has the ability to participate in the lessee’s employee benefit plans, if any, on the same
basis as other comparable employees of the lessee.
5. The lessee agrees to and remits to the lessor funds sufficient to cover the complete compensation,
including all payroll taxes, of the individual on or before a contractually agreed upon date or dates.
A nonemployee director does not satisfy this definition of employee. Nevertheless, nonemployee directors
acting in their role as members of a board of directors are treated as employees if those directors were elected
by the employer’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 nonemployee
directors for their services as directors. Awards granted to those individuals for other services shall be
accounted for as awards to nonemployees.
ASC 718-10
Identifying an Employee of a Physician Practice Management Entity

55-85A 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.
12
Chapter 2 — Scope
Determining whether a grantee meets the definition of an employee under ASC 718 is important for
certain aspects of the accounting for a share-based payment award. On the basis of an examination
of cases and rules, the IRS issued Revenue Ruling 87-41, which establishes 20 criteria for determining
whether an individual is an employee under common law. The degree of importance of each criterion
varies depending on the context in which the services of an individual are performed. In addition, the
criteria are designed as guides to help an entity determine whether an individual is an employee. An
entity should ensure that the substance of an arrangement is not obscured by attempts to achieve a
particular employment status. The criteria include the following:
• Instructions — “A worker who is required to comply with other persons’ instructions about
when, where, and how he or she is to work is ordinarily an employee. This control factor is
present if the person or persons for whom the services are performed have the right to require
compliance with instructions.”
• Continuing relationship — “A continuing relationship between the worker and the person or
persons for whom the services are performed indicates that an employer-employee relationship
exists. A continuing relationship may exist where work is performed at frequently recurring
although irregular intervals.”
• Set hours of work — “The establishment of set hours of work by the person or persons for whom
the services are performed is a factor indicating control.”
• Hiring, supervising, and paying assistants — “If the person or persons for whom the services are
performed hire, supervise, and pay assistants, that factor generally shows control over the
workers on the job. However, if one worker hires, supervises, and pays the other assistants
pursuant to a contract under which the worker agrees to provide materials and labor and under
which the worker is responsible only for the attainment of a result, this factor indicates an
independent contractor status.”
• Working on the employer’s premises — “If the work is performed on the premises of the person
or persons for whom the services are performed, that factor suggests control over the worker,
especially if the work could be done elsewhere. . . . Work done off the premises of the person
or persons receiving the services, such as at the office of the worker, indicates some freedom
from control. However, this fact by itself does not mean that the worker is not an employee. The
importance of this factor depends on the nature of the service involved and the extent to which
an employer generally would require that employees perform such services on the employer’s
premises. Control over the place of work is indicated when the person or persons for whom
the services are performed have the right to compel the worker to travel a designated route, to
canvass a territory within a certain time, or to work at specific places as required.”
• Full-time employment requirement — “If the worker must devote substantially full time to the
business of the person or persons for whom the services are performed, such person or
persons have control over the amount of time the worker spends working and impliedly restrict
the worker from doing other gainful work. An independent contractor on the other hand, is free
to work when and for whom he or she chooses.”
• Payment — “Payment by the hour, week, or month generally points to an employer-employee

relationship, provided that this method of payment is not just a convenient way of paying a lump
sum agreed upon as the cost of a job. Payment made by the job or on a straight commission
generally indicates that the worker is an independent contractor.”
See IRS Revenue Ruling 87-41 for additional information about assessing whether an individual is an
employee under common law.
13
Share-based payment awards granted to an individual who provides services to a pass-through entity
may be considered employee awards if, on the basis of the factors listed above, the individual qualifies
as an employee of the entity under common law. The fact that a pass-through entity does not classify
the grantee as an employee for U.S. payroll tax purposes does not, by itself, indicate that the grantee is
not an employee for accounting purposes.
2.3 Nonemployee Directors
ASC 718-10
Example 2: Definition of Employee

55-89 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.
55-90 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.
55-91 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.
Under an exception in ASC 718, a member of an entity’s board of directors who may not meet the
common law definition of an employee may be treated as an employee if certain conditions are met.
2.3.1 Parent-Entity Directors
A nonemployee member of a parent entity’s board of directors will be treated as an employee if (1) the
director was elected by the entity’s shareholders or (2) the board position will be subject to shareholder
election upon expiration of the director’s term.
2.3.2 Subsidiary Directors
A nonemployee member of a subsidiary’s board of directors who is granted awards will be treated as
an employee in the parent’s consolidated financial statements if the individual is granted awards for
services as a member of the parent company’s board of directors (and meets one of the conditions
described in the previous section).
14
Chapter 2 — Scope
Further, nonemployee members of a consolidated subsidiary’s board of directors that are granted
awards for their director services to the subsidiary will be considered employees under ASC 718 if
they were elected by minority shareholders who are not directly or indirectly controlled by the parent
or another member of the consolidated group. Such awards are accounted for under ASC 718 in the
parent company’s consolidated financial statements and in the separate financial statements of the
subsidiary. If the directors were not elected by minority shareholders of the subsidiary (i.e., they were
elected by the controlling shareholders or another member of the consolidated group), the awards
should be accounted for as nonemployee awards under ASC 718 in the parent company’s consolidated
financial statements. However, if they were elected by the subsidiary’s shareholders, including controlling
shareholders of the consolidated group, the awards granted for director services should be accounted
for as awards granted to employees under ASC 718 in the separate financial statements of the subsidiary.
2.4 Nonemployee Awards
While most of the guidance on share-based payments granted to nonemployees is aligned with the
requirements for share-based payments granted to employees, there remain some differences,
notably those related to the attribution of compensation cost and an entity’s election to measure a
nonemployee stock option award by using the contractual term instead of the expected term. See
Chapter 9 for additional information about accounting for nonemployee awards.
Connecting the Dots

If a grantee’s employment status changes from employee to nonemployee, an entity must
consider whether the share-based payment award was modified as a result of that change. For
example, an employee may be granted an equity-classified share-based payment award under
which continued vesting in the award is permitted notwithstanding a change in employment
status (e.g., the award will vest as long as the grantee continues to provide services to the
entity, whether as an employee or as an independent contractor). Such an award would not
be modified in connection with the change in employment status provided that the grantee
continues to provide substantive services to earn the award. The entity would continue to
recognize the original grant-date fair-value-based measure of the award and would recognize
the remaining cost in accordance with the nonemployee recognition guidance (see Section
9.3.1).
However, an entity may grant an award whose original terms prohibit the grantee from
continuing to vest in the award after a change in employment status. If the entity modifies
such an award concurrently with a change in employment status to permit continued vesting,
that change to the terms of the award represents a modification. Generally, this would result
in a Type III improbable-to-probable modification (see Section 6.3.3) because the employee
would not have otherwise provided the required service under the original terms of the award.
Accordingly, the modification-date fair-value-based measure of the award would be recognized
in accordance with the nonemployee recognition guidance (see Section 9.3.1).
15
2.5 Economic Interest Holders

ASC 718-10
15-4 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.
Economic Interest in an Entity

Any type or form of pecuniary interest or arrangement that an entity could issue or be a party to, including
equity securities; financial instruments with characteristics of equity, liabilities, or both; long-term debt and
other debt-financing arrangements; leases; and contractual arrangements such as management contracts,
service contracts, or intellectual property licenses.
An economic interest holder of a reporting entity may issue share-based payment awards in the
reporting entity’s equity for goods or services provided to the reporting entity. If so, the reporting entity
typically records the transaction as if it had issued the awards (with a corresponding capital contribution
from the economic interest holder) since the entity benefits from the compensation paid to the
grantees.
2.5.1 Investor Purchases of Shares From Grantees

On occasion, investors intending to acquire or increase their stake in an emerging nonpublic entity may
purchase shares from the founders of the nonpublic entity or other individuals who are also considered
grantees. The presumption in such transactions is that any consideration in excess of the fair value of
the shares is compensation paid to grantees. However, if there is sufficient evidence that a transaction is
an arm’s-length, orderly fair value transaction, it may instead be necessary to treat the transaction as a
data point in the estimation of the fair-value-based measurement of share-based payment awards. See
Section 4.12.3.2 for more information.
2.5.2 Share-Based Payments in an Economic Interest Holder’s Equity

An economic interest holder may issue awards of its own equity to grantees that provide goods
or services to a reporting entity (these can be employees of a reporting entity or nonemployees
providing goods or services to a reporting entity). An economic interest holder could be, for example,
a parent entity, another subsidiary of the parent (e.g., a sister subsidiary), an equity method investor,
an unrelated investor, or a third party. If there are various ownership and legal entity structures
(particularly partnerships and limited liability companies), it may be difficult for a reporting entity to
determine whether the awards are subject to ASC 718 or other U.S. GAAP (e.g., ASC 323 or ASC 815).
16
Chapter 2 — Scope
The determination of which guidance to apply could affect the awards’ classification, measurement, and
recognition in the reporting entity’s financial statements as well as the required disclosures. Accordingly,
the reporting entity should evaluate the following:
• Which legal entity is issuing the awards and whether the awards are indexed to or settled in that
entity’s equity — For example, if awards are settled in the equity of an unrelated investor, they
may not be share-based payments of the reporting entity that are accounted for under ASC 718.
• The economic substance of the legal entity issuing the awards — The evaluation should include
whether the entity has other substantive (1) investments or operations (outside of its ownership
in the reporting entity) and (2) investors. For example, if a legal entity that is an investor in the
reporting entity grants awards to employees of the reporting entity but is created solely as a
holding company (with no operations) by the reporting entity to issue awards to the reporting
entity’s employees, the legal entity’s purpose may be to issue awards to employees that
are effectively indexed to the reporting entity’s equity. In this circumstance, issuance of the
awards may not be substantively different from the reporting entity’s issuance of equity to its
employees. Accordingly, it may be appropriate to account for those awards under ASC 718. See
Example 2-4A.
• The legal entity’s relationship with the reporting entity — If the legal entity whose equity is the basis
for the awards has economic substance other than to issue awards to the reporting entity’s
employees or nonemployees, the accounting will depend on that entity’s relationship with the
reporting entity. For a discussion of awards issued by an entity to providers of goods or services
of another entity within a consolidated group, see Sections 2.8 and 2.9. For a discussion of
awards issued by an equity method investor to providers of goods or services of its equity
method investee, see Section 2.10.
• Whether the grantees are common law employees of the reporting entity — For example, if a parent
entity grants awards of its equity to employees of an entity that is (1) unrelated to the subsidiary
reporting entity (e.g., an unrelated management or advisory company) and (2) providing
nonemployee services to the reporting entity, the awards may be subject to ASC 718. However,
the accounting for nonemployee awards could be different under ASC 718 from that for
employee awards (see Chapter 9).
• Whether the reporting entity has an obligation to settle the awards issued — For example, if the
reporting entity has an obligation to settle awards granted to its employees or nonemployees
in the equity of another entity that is not the reporting entity’s parent, the awards may not be
subject to ASC 718. For a discussion of awards issued by a reporting entity that are settled in the
equity of an unrelated entity, see Section 2.11.
17
Example 2-4A
Entity C, the reporting entity, is a privately held limited liability company that is wholly owned by Entity B, a
limited partnership and holding company with no operations or assets other than its investment in C. Entity B is
controlled and consolidated by Entity A, a management company and the general partner, but B is also owned
by other investors. The ownership interests are as follows:
• Entity A — 15%
• Other investors — 82%
• Entity D — 3%
Other Investors Entity A, Inc.
Entity D, LLC
General Partner
and 15% Ownership
82% Ownership 3% Ownership
Awards
Entity B, LP
100% Ownership
Employed
Employees
Entity C, LLC
Entity D was created by A as a holding company with no operations or assets other than its investment in B
(which also has no operations or assets other than its investment in C). Under this structure, recipients of the
awards invest through D (an upper-tier LLC) and remain employees at C (the lower-tier LLC). Entity D obtained
the 3 percent ownership interest in B solely to grant equity awards equivalent to its ownership interest in B to
certain employees of C for services provided to C. The share-based payment awards will be settled in D’s equity,
which is a substantive class of equity that derives its value entirely from the value of C.
Entity C determines that the equity issued by D is substantively equivalent to its own equity. That is, D’s
equity derives its value exclusively from C as a result of D’s 3 percent ownership in B. Entity B’s equity,
in turn, derives its value exclusively from B’s 100 percent ownership of C (B and D hold no other assets).
Therefore, it is reasonable to conclude that the share-based payment awards issued by D to the employees
of C should be accounted for in C’s financial statements under ASC 718 as C’s share-based payment awards
since C’s employees effectively received share-based payment awards in C’s equity. That is, in substance and
in accordance with ASC 718-10-15-4, D (the economic interest holder) made a capital contribution to C (the
reporting entity), and C then made a share-based payment to its employees in exchange for services rendered.
18
Chapter 2 — Scope
2.6 Profits Interests
Nonpublic entities (often limited partnerships or limited liability companies) may grant special classes
of equity, frequently in the form of “profits interests.” In many cases, a waterfall calculation is used to
determine the payout to the different classes of shares or units. While arrangements vary, the waterfall
calculation often is performed to allocate distributions and proceeds to the profits interests only after
specified amounts (e.g., multiple of invested capital) or specified returns (e.g., internal rate of return on
invested capital) are first allocated to the other classes of equity. In addition, future profitability threshold
amounts or “hurdles” must be cleared before the grantee receives distributions so that, for tax purposes
on the grant date, the award has zero liquidation value. However, the award would have a fair value in
accordance with ASC 718. In certain cases, distributions on and realization of value from profits interests
are expected only from the proceeds from a liquidity event such as a sale or IPO of the entity, provided
that the sale or IPO exceeds a target hurdle rate.
While the legal and economic form of these awards can vary, they should be accounted for on the basis
of their substance. If an award has the characteristics of an equity interest, it represents a substantive
class of equity and should be accounted for under ASC 718; however, an award that is, in substance, a
performance bonus or a profit-sharing arrangement would be accounted for as such in accordance with
other U.S. GAAP (e.g., typically ASC 710 and ASC 450 for employee arrangements).
Does the
award represent a
substantive class of
equity?
Yes No
Account for in accordance with The award is, in substance, a

ASC 718. Perform additional performance bonus or profit-
analysis to determine sharing arrangement. Account for
classification. in accordance with other U.S. GAAP.
In a speech at the December 2006 AICPA Conference on Current SEC and PCAOB Developments, Joseph
Ucuzoglu, then a professional accounting fellow in the SEC’s Office of the Chief Accountant, discussed
observations of the SEC staff related to special classes of equity and associated financial reporting
considerations. Specifically, he stated:
Public companies often create special classes of stock to more closely align the compensation of an employee with
the operating performance of a portion of the business with which he or she has oversight responsibility. That is,
rather than granting an equity interest in the parent company, employees are granted instruments whose value is
based predominantly on the operations of a particular subset of the parent’s operations. The staff has observed
the use of these arrangements in diverse industries, ranging from the grant of an interest in a group of restaurants
that an employee oversees, to the grant of an interest in a particular investment fund that an employee manages.
Similarly, pre-IPO companies often create special classes of stock to provide employees with an opportunity
to participate in any appreciation realized through a future initial public offering or sale of the company, with
limited opportunity for gain if no liquidity event occurs. In order to accomplish this objective, the special class
is often subordinate in both dividend rights and liquidation preference to the company’s main class of stock,
and may have little or no claim to the underlying net assets of the company. In many cases, the terms of these
instruments mandate conversion into the entity’s main class of common stock upon the completion of an IPO.
19
Several accounting issues arise when a special class of stock is granted to employees. First and foremost, one
must look through the legal form of the instrument to determine whether the instrument is in fact a substantive
class of equity for accounting purposes, or is instead similar to a performance bonus or profit sharing
arrangement. When making this determination, all relevant features of the special class must be considered.
There are no bright lines or litmus tests. When few if any assets underlie the special class, or the holder’s claim
to those assets is heavily subordinated, the arrangement often has characteristics of a performance bonus
or profit-sharing arrangement. Instruments that provide the holder with substantive voting rights and pari
passu dividend rights are at times indicative of an equity interest. Consideration should also be given to any
investment required, and any put and call rights that may limit the employee’s downside risk or provide for
cash settlement. Many of these factors were contained in Issues 28 and 40 of EITF Issue 00-23, which provided
guidance on the accounting under APB Opinion No. 25 for certain of these arrangements.
When the substance of the instrument is that of a performance bonus or profit sharing arrangement, it
should be accounted for as such. In those circumstances, any returns to the employee should be reflected
as compensation expense, not as equity distributions or minority interest expense. Further, if the employee
remitted consideration at the outset of the arrangement in exchange for the instrument, such consideration
should generally be reflected in the balance sheet as a deposit liability.
On the other hand, when the substance of the arrangement is in fact that of a substantive class of equity,
questions often arise as to the appropriate valuation of the instrument for the purpose of recording
compensation expense pursuant to FASB Statement No. 123R. These instruments, by design, often derive
all or substantially all of their value from the right to participate in future share price appreciation or profits.
Accordingly, the staff has rejected the use of valuation methodologies that focus predominantly on the
amount that would be realized by the holder in a current liquidation, as such an approach fails to capture the
substantial upside potential of the security. [Footnotes omitted]
Although Issues 28 and 40 of EITF Issue 00-23 (referred to in the speech above) were superseded and
nullified by FASB Statement 123(R) (codified in ASC 718), the indicators provided in them are useful in
the determination of whether profits interests represent a substantive class of equity. Those indicators,
as well as others, include:
• The legal form of the instrument (a profits interest can only be a substantive class of equity if it is
legal form equity).
• Distribution rights, particularly after vesting.

• Claims to the residual assets of the entity upon liquidation.
• Substantive net assets underlying the interest.
• Retention of vested interests upon termination.
• Any investment required to purchase the shares or units.
• Transferability after vesting.
• Voting rights commensurate with those of other substantive equity holders.
• An entity’s intent in issuing the interest (i.e., whether the entity is attempting to align the holder’s
interests with those of other substantive equity holders).
• Provisions for realization of value.

• Repurchase features that may affect exposure to risks and rewards.
A key focus in the determination of whether profits interests represent a substantive class of equity is
the ability to retain residual interests upon vesting, including after termination. This includes the ability to
realize value that is tied to the underlying value of the entity’s net assets, through distributions that are
based on an entity’s profitability and operations as well as on any liquidity event (even if through a lower
level of waterfall distributions). By contrast, in a profit-sharing arrangement, a grantee typically is only
able to participate in the entity’s profits while providing goods or services to the entity, and a residual
interest is not retained upon termination. A profit-sharing arrangement may also contain provisions
20
Chapter 2 — Scope
(e.g., repurchase features) that limit the grantee’s risks and rewards (e.g., a repurchase feature that,
upon termination of employment, is at cost or a nominal amount).
In addition, not all the indicators described above are given equal weight. While voting rights and
transferability may be indicative of an equity interest, the absence of such features would not preclude
the interest from being considered a substantive class of equity. Nonpublic entities frequently issue
equity interests that lack voting rights (particularly to noncontrolling interest holders) and have
transferability restrictions. Further, if a grantee does not make an initial investment to purchase an
equity interest, the equity interest may still be a substantive class of equity. In that circumstance,
consideration for the shares or units is in the form of goods or services.
In determining whether a vested residual interest is retained after termination, an entity typically focuses
on what happens to the interest if the grantee is an employee who voluntarily terminates employment
without good reason3 or if the grantee is a nonemployee who ceases to provide goods or services. For
example, if an employee award is legally vested but is substantively forfeited upon voluntary termination
without good reason (e.g., the entity can repurchase the legally vested award at the lower of cost or
fair value upon such termination event), the award will most likely be a profit-sharing arrangement (see
Section 3.4.3 for a discussion of repurchase features that function as vesting conditions). By contrast, if
an employee award is legally vested but substantively forfeited only upon termination for cause (e.g., the
entity can repurchase the legally vested award at the lower of cost or fair value upon such termination
event), that feature would not affect the analysis since it functions as a clawback provision (see Section
3.9 for a discussion of repurchase features that function as clawback provisions).
An entity should consider the substance of an award rather than its form. For example, an award may
legally vest immediately under an agreement; however, the vesting may not be substantive if the award
cannot be transferred or otherwise monetized until an IPO occurs and the entity can repurchase
the award for no consideration if the grantee terminates employment or ceases to provide goods
or services before the IPO. We would most likely conclude that such an award has a substantive
performance condition that affects vesting (i.e., an IPO is a vesting condition) even though the award was
deemed “immediately vested” according to the agreement.
From a valuation standpoint, nonpublic entities might consider whether the profits interests that
represent a substantive class of equity have no value on the grant date. For example, if the entity were
liquidated on the grant date, the waterfall calculation would result in no payment to the special class.
However, in a manner consistent with the SEC staff’s speech above, the profits interests generally have a
fair value because of the upside potential of the equity.
Connecting the Dots

Once a nonpublic entity concludes that the profits interests are subject to the guidance in ASC
718 because they represent a substantive class of equity, the entity would next need to assess
the conditions in ASC 718-10-25-6 through 25-19A to determine whether the award should be
equity- or liability-classified. See Chapter 5 for a detailed discussion of how to determine the
classification of awards.
3
A significant demotion, a significant reduction in compensation, or a significant relocation are commonly considered “good reasons” for
termination.
21
2.7 Rabbi Trusts
Many entities have arrangements that allow their employees to defer some or all of their earned
compensation (i.e., salary or bonus). Sometimes the employer uses a “rabbi trust”4 to hold assets from
which nonqualified deferred compensation payments will be made. ASC 710 provides guidance on
deferred compensation arrangements in which assets equal to compensation amounts earned by
employees are placed in a rabbi trust. Such arrangements often permit employees to diversify their
accounts by investing in cash, the employer’s stock, nonemployer securities, or a combination of these
options. In all cases, the employer consolidates the rabbi trust in the employer’s financial statements.
The guidance in ASC 710 refers to four types of deferred compensation arrangements involving rabbi
trusts. These four arrangement types, known as plans A, B, C, and D, differ on the basis of whether the
plan permits diversification, whether the employee has elected to diversify, and the allowable forms of
settlement:
Plan Diversification Settlement Options Permitted Under Plan
A Not permitted Delivery of a fixed number of shares of employer stock
B Not permitted Delivery of cash or shares of employer stock
C Permitted, but employee has not diversified Delivery of cash, shares of employer stock, or diversified
assets
D Permitted, and employee has diversified Delivery of cash, shares of employer stock, or diversified
assets
Deferred compensation arrangements in which the amounts earned are indexed to, or can be settled
in, an entity’s own stock before being placed into a rabbi trust are within the scope of ASC 718. When
the amounts earned in a deferred compensation arrangement (1) are within the scope of ASC 718
before being placed into a rabbi trust and (2) can be settled only in the employer’s stock (i.e., Plan A), the
arrangement would be accounted for as an equity award under ASC 718 before the amounts earned are
placed into the trust (provided that all other criteria for equity classification have been met). In addition,
the deferred compensation arrangement would remain classified in equity and would therefore not
need to be remeasured under ASC 710 after the amounts earned are placed into the rabbi trust.
Similarly, when the amounts earned in a deferred compensation arrangement (1) are within the scope
of ASC 718 before being placed into a rabbi trust and (2) can be settled only in the employer’s stock or
cash at the election of the employee (i.e., Plan B), the arrangement may be accounted for as a liability
or equity award under ASC 718 before the amounts earned are placed into the trust. The deferred
compensation arrangement would be classified as a liability after the amounts earned are placed into
the rabbi trust.
For all other deferred compensation arrangements in which amounts earned are placed into a rabbi
trust, the accounting depends on the terms of the arrangement and on whether the arrangement is
viewed either as one plan or as substantively consisting of two plans.
4
Rabbi trusts are generally used as funding vehicles to provide for the deferral of taxation to the employee receiving the compensation. That is, in
a nonqualified deferred compensation plan, employees defer the receipt of compensation amounts earned by placing the amounts earned in a
rabbi trust. By deferring receipt of the amounts earned, the employees are also deferring the taxability of those amounts. The employees will be
subsequently taxed upon receiving the amounts that have been placed in the rabbi trust.
22
Chapter 2 — Scope
Connecting the Dots

For all plans except Plan A, SEC registrants (or entities electing to apply SEC requirements)
should consider ASR 268 and ASC 480-10-S99-3A, as discussed in SAB Topic 14.E, under which
presentation must occur outside of permanent equity (i.e., as temporary or mezzanine equity)
when redemption is outside the control of the entity. See Section 5.10 for discussion on the SEC
guidance on temporary equity.
2.7.1 Accounting for a Deferred Compensation Arrangement as Two Plans

(Plans C and D)
For an arrangement to be viewed as substantively consisting of two plans, the following two criteria must
be met:
• There must be a reasonable period within which the employee is required to be subjected
to the risks and rewards of ownership (i.e., to all the stock price movements of the employer’s
stock). ASC 718-10-25-9 defines this period as six months or more. Accordingly, once the
share-based payment award is vested, it would need to remain indexed to the employer’s stock
for at least six months. After six months, the employee could liquidate the employer’s stock
into a diversified account (i.e., a rabbi trust), which would be the beginning of the deferred
compensation arrangement.
• The option to defer the amounts earned under the share-based payment award must be
entirely elective. If the employee is forced into a diversified account (i.e., a rabbi trust), the award
would most likely be considered mandatorily redeemable under ASC 480. That is, the deferred
compensation arrangement would have to be classified as a liability. Therefore, if the employee
is “forced” to accept a liability in satisfaction of the share-based payment award, redemption is
deemed mandatory. Accordingly, the entire arrangement would be accounted for as a liability
from the grant date of the share-based payment award and not just from the beginning of the
deferred compensation arrangement.
If the above two criteria are met, the deferred compensation arrangement is viewed as a share-based
payment arrangement that is subsequently “converted” into a diversified deferred compensation
arrangement (i.e., two plans). Accordingly, an entity applies the guidance in ASC 718 until the amounts
earned are placed into the rabbi trust (“the share-based payment award”) and then applies the guidance
in ASC 710 until the deferred amounts are received by the employee (“the deferred compensation
arrangement”).
However, if the above two criteria are met and equity classification is achieved from the grant date of
the share-based payment award until the amounts earned are placed into the rabbi trust, a public entity
also must consider the guidance in ASR 268 (FRR Section 211) and ASC 480-10-S99-3A. ASC 480-10-
S99-3A addresses share-based payment arrangements with employees whose terms may permit
redemption of the employer’s shares for cash or other assets. Since the distribution of the amounts
earned under the share-based payment award into a diversified account is viewed as settlement in
cash or other assets (i.e., because the deferred compensation obligation must be classified as a liability
pursuant to ASC 710 once the amounts are placed into the rabbi trust), the share-based payment
award would be subject to the guidance in ASC 480-10-S99-3A. The guidance in ASC 480-10-S99-3A
requires classification in temporary (mezzanine) equity from the grant date of the share-based payment
award until the beginning of the deferred compensation arrangement. At the beginning of the deferred
compensation arrangement, the amounts placed into the rabbi trust would be classified as a liability
under ASC 710.
23
2.7.2 Accounting for a Deferred Compensation Arrangement as One Plan

(Plans C and D)
If the two criteria in the previous section are not met, the deferred compensation arrangement is viewed
as one plan. When an arrangement is viewed as one plan, the diversification option would result in
liability classification under ASC 718 for the share-based payment award from the grant date to the date
the amounts earned are placed into the rabbi trust. Under ASC 718, an award that allows an employee
to diversify outside of the employer’s stock would be indexed to something other than a market,
performance, or service condition (i.e., the ultimate value received by the employee also is indexed to
the performance of the assets into which they diversified). In accordance with ASC 718-10-25-13, an
arrangement that is indexed to an “other” condition is classified as a share-based liability irrespective
of whether the employee ultimately receives cash, other assets, or the employer’s stock. (See Chapter
7 for more detailed guidance on the accounting treatment of liability awards.) Accordingly, the deferred
compensation arrangement would be classified as a share-based liability from the grant date until the
amounts earned are placed into the rabbi trust. Once placed into the rabbi trust, the amounts earned
would be classified as a liability pursuant to ASC 710 until the deferred amounts are received by the
employee.
2.8 Consolidated Financial Statements

Share-based payment awards issued to grantees of entities within a consolidated group include, for
example, awards that a parent grants to its subsidiary’s employees or nonemployees and that are
indexed to or settled in the parent’s equity instruments. A consolidated subsidiary may also grant
share-based payment awards to employees or nonemployees of the parent or another subsidiary
that are indexed to or settled in the equity of the consolidated subsidiary. In the consolidated financial
statements, because the share-based payment awards are issued to employees or nonemployees of the
consolidated group and indexed to or settled in the equity of an entity within the consolidated group,
the awards are within the scope of ASC 718.
While FASB Statement 123(R) (codified in ASC 718) nullified FASB Interpretation 44, paragraph 11 of
Interpretation 44 remains applicable by analogy. It stated, in part:
In consolidated financial statements, the evaluation of whether a grantee is an employee under Opinion
25 is made at the consolidated group level and stock compensation based on the stock of a subsidiary is
deemed to be stock compensation based on the stock of the consolidated group (the employer). Therefore,
in the consolidated financial statements, stock compensation granted based on the stock of any
consolidated group member shall be accounted for under Opinion 25 if the grantee meets the
definition of an employee for any entity in the consolidated group. For example, Opinion 25 applies
to the accounting in the consolidated financial statements for awards based on parent stock granted to
employees of a (consolidated) subsidiary and to awards in stock of a (consolidated) subsidiary granted to
employees of the parent. Also, Opinion 25 applies to the accounting in the consolidated financial statements
for awards based on a subsidiary’s stock granted to the employees of another subsidiary. This guidance applies
only to consolidated financial statements. [Emphasis added]
Accordingly, the parent entity accounts for the awards under ASC 718 when preparing its consolidated
financial statements.
24
Chapter 2 — Scope
2.9 Separate Financial Statements

The accounting for share-based payment transactions in the separate financial statements of each
entity within a consolidated group is somewhat complicated. Before FASB Statement 123(R) (codified in
ASC 718), entities applied the guidance in Question 4 of FASB Interpretation 44 and Issues 21 and 22
of EITF Issue 00-23 when accounting for such transactions. Although FASB Statement 123(R) (codified
in ASC 718) subsequently superseded and nullified Interpretation 44 and Issue 00-23, entities should
continue to analogize to this guidance when accounting for consolidated-group share-based payment
transactions.
The share-based payment awards of a consolidated subsidiary that are issued to employees of that
subsidiary and are indexed to and settled in equity of the subsidiary’s parent are within the scope of ASC
718. Although ASC 718 does not specifically address such awards, they would be within the scope of ASC
718 by analogy to paragraph 14 of Interpretation 44. Paragraph 14 states, in part:
[A]n exception is made to require the application of Opinion 25 to stock compensation based on stock of the
parent company granted to employees of a consolidated subsidiary for purposes of reporting in the separate
financial statements of that subsidiary. The exception applies only to stock compensation based on stock
of the parent company (accounted for under Opinion 25 in the consolidated financial statements) granted
to employees of an entity that is part of the consolidated group. [Emphasis added]
Under the exception in Interpretation 44, an entity treated the stock of the parent entity as though it
were the stock of the consolidated subsidiary when reporting in the separate financial statements of
the subsidiary. We believe that the same analogy can be applied to awards granted to the subsidiary’s
nonemployee providers of goods or services. The exception did not, however, extend to share-based
payment awards “granted (a) to the subsidiary’s employees based on the stock of another subsidiary
in the consolidated group or (b) by the subsidiary to employees of the parent or another subsidiary.”
Therefore, the share-based payment awards of a consolidated subsidiary that reports separate financial
statements and grants such awards to employees or nonemployees of the parent or another subsidiary,
and that are indexed to and settled in the equity of the consolidated subsidiary, are not within the scope
of ASC 718.
Neither Interpretation 44 nor ASC 718 specifically addresses the accounting for these awards. Such
guidance is contained in Issue 21 of EITF Issue 00-23. The conclusion in Issue 21 of EITF Issue 00-23
states that the parent (controlling entity) can always direct subsidiaries (controlled entities) within
the consolidated group to grant share-based payment awards to the parent’s employees and to
the employees of other subsidiaries in the consolidated group. Therefore, in its separate financial
statements, the subsidiary granting the awards measures the awards at their fair-value-based measure
as of the grant date. That amount is recognized as a dividend from the subsidiary to the parent; a
corresponding amount is recognized as equity. The EITF’s reasoning is as follows:
Because the controlling entity has the discretion to require entities it controls to enter into a variety of
transactions, recognizing the transaction as a dividend more closely mirrors the economics of the arrangement
because it will not be clear that the entity granting the stock compensation has received goods or services in
return for that grant, and if so, whether the fair value of those goods or services approximates the value of the
equity awards.
Likewise, share-based payment awards that are issued to employees or nonemployees of a subsidiary
and indexed to and settled in another subsidiary’s equity are also not within the scope of ASC 718. In
its separate financial statements, the subsidiary issuing the awards would apply the guidance in Issue
21 of EITF Issue 00-23 because the parent (controlling entity) can always direct subsidiaries (controlled
entities) within the consolidated group to grant share-based payment awards to its employees or
nonemployees and to the employees or nonemployees of other subsidiaries in the consolidated
group. In theory, the subsidiary granting the share-based payment award is accounting for the grant
25
as if the awards were issued to the parent and as if, after receiving the awards, the parent issues the
same awards to another subsidiary within the consolidated group. Therefore, in its separate financial
statements, the subsidiary issuing the awards measures the awards at their fair-value-based measure
as of the grant date. That amount is recognized as a dividend from the subsidiary to the parent; a
corresponding amount is recognized as equity.
In addition, in its separate financial statements, the subsidiary whose employees or nonemployees are
receiving the awards would apply the guidance in Issue 22 of EITF Issue 00-23, which specifies that the
awards are accounted for as compensation cost on the basis of their fair value. We believe that in a
manner similar to the entity issuing the awards, if the subsidiary whose employees or nonemployees are
receiving the awards has no obligation to settle those awards, it is acceptable to measure the awards at
their fair-value-based measure as of the grant date. The subsidiary would also account for the offsetting
entry to compensation cost as a credit to equity (i.e., a capital contribution from or on behalf of the
parent). By contrast, if the subsidiary whose employees or nonemployees are receiving the awards has
an obligation to settle those awards, the awards generally would be accounted for under ASC 815 (see
Section 2.11).
The table below summarizes the accounting for awards in a parent’s consolidated financial statements
and the separate financial statements of its wholly owned subsidiaries, A and B, in three scenarios.
Parent’s Consolidated Subsidiary A’s Separate Subsidiary B’s Separate

Awards Financial Statements Financial Statements Financial Statements
Share-based The awards are accounted The awards are within N/A
payment awards for as share-based the scope of ASC 718.
issued to employees/ payment awards within Compensation cost for
nonemployees of A and the scope of ASC 718. the awards is recognized
indexed to and settled at their fair-value-based
in the parent’s equity measure as of the grant
date.
If A does not reimburse

the parent for the
awards, it makes an
offsetting entry to equity
to represent a capital
contribution by the
parent.
Share-based payment The awards are accounted The awards are not N/A
awards issued to the for as share-based within the scope of
parent’s employees/ payment awards within ASC 718. Subsidiary A
nonemployees and the scope of ASC 718. measures the awards
indexed to and settled at their fair-value-based
in A’s equity measure as of the grant
date and recognizes that
amount as a dividend
from itself to the
parent; it recognizes a
corresponding amount as
equity.
26
Chapter 2 — Scope
(Table continued)
Parent’s Consolidated Subsidiary A’s Separate Subsidiary B’s Separate

Awards Financial Statements Financial Statements Financial Statements
Share-based The awards are accounted The awards are not within Subsidiary B recognizes
payment awards for as share-based the scope of ASC 718. compensation cost for the
issued to employees/ payment awards within Subsidiary A accounts for awards at their fair-value-
nonemployees of B and the scope of ASC 718. them as if (1) they were based measure as of the
indexed to and settled issued to the parent and grant date if it does not
in A’s equity (2) the parent then issued have an obligation to settle
them to B. Subsidiary A the awards. It accounts
measures the awards for the offsetting entry
at their fair-value-based to compensation cost as
measure as of the grant a credit to equity (i.e., a
date and recognizes that capital contribution from
amount as a dividend or on behalf of the parent).
from itself to the If it has an obligation to
parent; it recognizes a settle the awards, it would
corresponding amount as generally apply ASC 815.
equity.
2.10 Equity Method Investments

ASC 505-10
25-3 Paragraphs 323-10-25-3 through 25-5 provide guidance on accounting for share-based compensation
services to the investee that are used or consumed in the investee’s operations. An investee shall recognize
the costs of the share-based payment incurred by the investor on its behalf, and a corresponding capital
contribution, as the costs are incurred on its behalf (that is, in the same period(s) as if the investor had
paid cash to employees and nonemployees of the investee following the guidance in Topic 718 on stock
compensation.
ASC 323-10
Stock-Based Compensation Granted to Employees and Nonemployees of an Equity Method Investee

25-3 Paragraphs 323-10-25-4 through 25-6 provide guidance on accounting for share-based payment awards
services to the investee that are used or consumed in the investee’s operations when no proportionate funding
by the other investors occurs and the investor does not receive any increase in the investor’s relative ownership
percentage of the investee. That guidance assumes that the investor’s grant of share-based payment awards to
employees or nonemployees of the equity method investee was not agreed to in connection with the investor’s
acquisition of an interest in the investee. That guidance applies to share-based payment awards granted to
employees or nonemployees of an investee by an investor based on that investor’s stock (that is, stock of the
investor or other equity instruments indexed to, and potentially settled in, stock of the investor).
25-4 In the circumstances described in paragraph 323-10-25-3, a contributing investor shall expense the cost
of share-based payment awards granted to employees and nonemployees of an equity method investee as
incurred (that is, in the same period the costs are recognized by the investee) to the extent that the investor’s
claim on the investee’s book value has not been increased.
27
25-5 In the circumstances described in paragraph 323-10-25-3, other equity method investors in an investee
(that is, noncontributing investors) shall recognize income equal to the amount that their interest in the
investee’s net book value has increased (that is, their percentage share of the contributed capital recognized by
the investee) as a result of the disproportionate funding of the compensation costs. Further, those other equity
method investors shall recognize their percentage share of earnings or losses in the investee (inclusive of any
expense recognized by the investee for the share-based compensation funded on its behalf).
25-6 Example 2 (see paragraph 323-10-55-19) illustrates the application of this guidance for share-based
compensation granted to employees of an equity method investee.
Share-Based Compensation Granted to Employees and Nonemployees of an Equity Method Investee

30-3 Share-based compensation cost recognized in accordance with paragraph 323-10-25-4 shall be measured
initially at fair value in accordance with Topic 718. Example 2 (see paragraph 323-10-55-19) illustrates the
application of this guidance.
Example 2: Share-Based Compensation Granted to Employees of an Equity Method Investee

55-19 This Example illustrates the guidance in paragraphs 323-10-25-3 and 323-10-30-3 for share-based
compensation by an investor granted to employees of an equity method investee. This Example is equally
applicable to share-based awards granted by an investor to nonemployees that provide goods or services to an
equity method investee that are used or consumed in the investee’s operations.
55-20 Entity A owns a 40 percent interest in Entity B and accounts for its investment under the equity method.
On January 1, 20X1, Entity A grants 10,000 stock options (in the stock of Entity A) to employees of Entity B.
The stock options cliff-vest in three years. If an employee of Entity B fails to vest in a stock option, the option
is returned to Entity A (that is, Entity B does not retain the underlying stock). The owners of the remaining 60
percent interest in Entity B have not shared in the funding of the stock options granted to employees of Entity
B on any basis and Entity A was not obligated to grant the stock options under any preexisting agreement with
Entity B or the other investors. Entity B will capitalize the share-based compensation costs recognized over
the first year of the three-year vesting period as part of the cost of an internally constructed fixed asset (the
internally constructed fixed asset will be completed on December 31, 20X1).
55-21 Before granting the stock options, Entity A’s investment balance is $800,000, and the book value of Entity
B’s net assets equals $2,000,000. Entity B will not begin depreciating the internally constructed fixed asset until
it is complete and ready for its intended use and, therefore, no related depreciation expense (or compensation
expense relating to the stock options) will be recognized between January 1, 20X1, and December 31, 20X1. For
the years ending December 31, 20X2, and December 31, 20X3, Entity B will recognize depreciation expense (on
the internally constructed fixed asset) and compensation expense (for the cost of the stock options relating to
Years 2 and 3 of the vesting period). After recognizing those expenses, Entity B has net income of $200,000 for
the fiscal years ending December 31, 20X1, December 31, 20X2, and December 31, 20X3.
55-22 Entity C also owns a 40 percent interest in Entity B. On January 1, 20X1, before granting the stock options,
Entity C’s investment balance is $800,000.
55-23 Assume that the fair value of the stock options granted by Entity A to employees of Entity B is $120,000
on January 1, 20X1. Under Topic 718, the fair value of share-based compensation should be measured at the
grant date. This Example assumes that the stock options issued are classified as equity and ignores the effect
of forfeitures.
28
Chapter 2 — Scope
55-24 Entity A would make the following journal entries.
12/31/20X1 12/31/20X2 12/31/20X3
To record cost of stock compensation and Entity C’s additional investment for costs incurred by
Entity A on behalf of investee
Entity A (Contributing Investor)

Investment in Entity B(a) $ 16,000 $ 16,000 $ 16,000
Expense (b)
24,000 24,000 24,000
Additional paid-in capital $ 40,000 $ 40,000 $ 40,000
Entity B (investee)
Fixed asset $ 40,000 — —
Expense — $ 40,000 $ 40,000
Entity C (noncontributing investor)

Investment in Entity B $ 16,000 $ 16,000 $ 16,000
Contribution income (c)
$ 16,000 $ 16,000 $ 16,000
To record Entity A’s and Entity C’s share of the earnings of investee (same entry for both Entity A
and Entity C)
Entity A and Entity C

Equity in earnings of Entity B $ 80,000 $ 80,000 $ 80,000
Consolidated impact of all the entries made by Entity A and Entity C
Entity A
Expense 24,000 24,000 24,000
Equity in earnings of Entity B 80,000 80,000 80,000
Entity C
Contribution income $ 16,000 $ 16,000 $ 16,000
(a) Entity A recognizes as an expense the portion of the costs incurred that benefits the other investors (in this Example, 60
percent of the cost or $24,000 in 20X1, 20X2, and 20X3) and recognizes the remaining cost (40 percent) as an increase
to the investment in Entity B. As Entity B has recognized the cost associated with the stock-based compensation
incurred on its behalf, the portion of the cost recognized by Entity A as an increase to its investment in Entity B (40
percent) is expensed in the appropriate period when Entity A recognizes its share of the earnings of Entity B.
(b) It may be appropriate to classify the debit (expense) within the same income statement caption as equity in earnings of
Entity B.
(c) This amount represents Entity C’s 40 percent interest in the additional paid-in capital recognized by Entity B related
to the cost incurred by the third-party investor. It may be appropriate to classify the credit (income) within the same
income statement caption as equity in earnings of Entity B.
29
55-25 A rollforward of Entity B’s net assets and a reconciliation to Entity A’s and Entity C’s ending investment
accounts follows.
12/31/20X1 12/31/20X2 12/31/20X3
Net assets of Entity B

Beginning net assets $ 2,000,000 $ 2,240,000 $ 2,480,000
Contributed capital 40,000 460,000 40,000
Net income 200,000 200,000 200,000
Ending net assets $ 2,240,000 $ 2,480,000 $ 2,720,000
Entity A’s and Entity C’s share × 40% × 40% × 40%
Entity A’s and Entity C’s equity in net assets of Entity B 896,000 992,000 1,088,000
Entity A’s and Entity C’s ending investment balance 896,000 992,000 1,088,000
Remaining unamortized basis difference $ — $ — $ —
55-26 A summary of the calculation of share-based compensation cost by year follows.
Calculation of the Share-Based Compensation Cost by Year
A = Grant C = (A × B) Amount
Date Fair of Cumulative D = Cumulative E=C–D
Year Value of B=% Compensation Cost Cost Previously Current Year
Ended Options Vested to Be Recognized Recognized Cost
20X1 $ 120,000 33% $ 40,000 $ — $ 40,000
20X2 $ 120,000 66% $ 80,000 $ 40,000 $ 40,000
20X3 $ 120,000 100% $ 120,000 $ 80,000 $ 40,000
Share-based payment awards may be (1) issued by an equity method investor to employees or
nonemployees of an equity method investee and (2) indexed to, or settled in, the equity of the investor.
ASC 323-10-25-3 through 25-5 and ASC 505-10-25-3 address the accounting related to the financial
statements of the equity method investor, the equity method investee, and the noncontributing
investor(s). This guidance does not apply to share-based payment awards issued to grantees for goods
or services provided to the investor that are indexed to, or settled in, the equity of the investee (as
opposed to the equity of the investor). See Section 2.11 for further guidance on the accounting for
awards that are issued to grantees and indexed to and settled in shares of an unrelated entity.
Note that the guidance in U.S. GAAP does not address an investee’s reimbursements to the contributing
investor. Sections 2.10.4 through 2.10.6 discuss this scenario; however, there may be other acceptable
views on the contributing investor’s, investee’s, and noncontributing investor’s accounting for such
reimbursements.
30
Chapter 2 — Scope
2.10.1 Accounting in the Financial Statements of the Contributing Investor

Issuing the Awards
ASC 323-10-25-3 and 25-4 indicate that an investor should recognize (1) the entire cost (not just the
portion of the cost associated with the investor’s ownership interest) of share-based payment awards
granted to employees or nonemployees of an investee as an expense and (2) a corresponding amount
in the investor’s equity. However, the cost associated with the investor’s ownership interest will be
recognized as an expense when it records its share of the investee’s earnings (because its share of
the investee’s earnings includes the awards’ expense). In addition, the entire cost (and corresponding
equity) should be recorded as incurred (i.e., in the same period(s) as if the investor had paid cash to the
investee’s employees or nonemployees). The cost of the share-based payment awards is a fair-value-
based amount that is consistent with the guidance in ASC 718. As noted in ASC 323-10-S99-4,
“[i]nvestors that are SEC registrants should classify any income or expense resulting from application
of this guidance in the same income statement caption as the equity in earnings (or losses) of the
investee.” Although ASC 323-10-S99-4 refers to SEC registrants, reporting entities that are not SEC
registrants should consider applying the same guidance.
2.10.2 Accounting in the Financial Statements of the Investee Receiving the

Awards
ASC 505-10-25-3 indicates that an investee should recognize (1) the entire cost of share-based payment
awards incurred by the investor on the investee’s behalf as compensation cost and (2) a corresponding
amount as a capital contribution. The cost of the share-based payment awards is a fair-value-based
amount that is consistent with the guidance in ASC 718. In addition, the compensation cost (and
corresponding capital contribution) should be recorded as incurred (i.e., in the same period(s) as if the
investor had paid cash to the investee’s employees or nonemployees).
2.10.3 Accounting in the Financial Statements of the Noncontributing

Investors
ASC 323-10-25-5 states that noncontributing investors “shall recognize income equal to the amount
that their interest in the investee’s net book value has increased (that is, their percentage share of the
contributed capital recognized by the investee)” as a result of the capital contribution by the investor
issuing the awards. In addition, the noncontributing investors “shall recognize their percentage share
of earnings or losses in the investee (inclusive of any expense recognized by the investee for the share-
based compensation funded on its behalf).” That is, the noncontributing investors should recognize
their share of the earnings or losses of the investee (including the compensation cost recognized for the
share-based payment awards issued by the equity method investor) in accordance with ASC 323-10. As
noted in ASC 323-10-S99-4, “[i]nvestors that are SEC registrants should classify any income or expense
resulting from application of this guidance in the same income statement caption as the equity in
earnings (or losses) of the investee.” Although ASC 323-10-S99-4 refers to SEC registrants, reporting
entities that are not SEC registrants should consider applying the same guidance.
31
2.10.4 Accounting in the Financial Statements of the Contributing Investor

Receiving the Reimbursement
If an investee reimburses a contributing investor for share-based payment awards, the contributing
investor generally records income, with a corresponding amount recorded in equity, in the same periods
as the cost that is recognized for issuing the awards. Therefore, the issuance of the awards by the
contributing investor and the subsequent reimbursement by the investee may not affect the net income
(loss) of the contributing investor. That is, if the reimbursement received by the investor equals the
compensation cost recognized for the awards granted, the cost of issuing the awards and the income
for the reimbursement of the awards will be equal and offsetting and will be recorded in the same
reporting periods in the contributing investor’s income statement.
2.10.5 Accounting in the Financial Statements of the Investee Receiving the

Awards and Making the Reimbursement
If an investee reimburses a contributing investor for share-based payment awards, the investee
generally accrues a dividend to the contributing investor for the amount of the reimbursement in the
same periods as the capital contribution from the contributing investor. The recognition of a dividend is
generally appropriate given that the issuance of the awards resulted in a capital contribution from the
contributing investor.
2.10.6 Accounting in the Financial Statements of the Noncontributing

Investors (When the Investee Reimburses the Contributing Investor)
If an investee reimburses a contributing investor for share-based payment awards, the noncontributing
investor or investors generally recognize a loss equal to the amount that their interest in the investee’s
net book value has decreased (i.e., their percentage share of the distributed capital recognized by the
investee) as a result of the reimbursement to the contributing investor. The recognition of a loss by the
noncontributing investors is appropriate given that their interest in the investee’s net book value has
decreased as a result of the reimbursement provided to the investor issuing the awards.
2.11 Unrelated Entity Awards

ASC 815-10
Options Granted to Employees and Nonemployees

45-10 Subsequent changes in the fair value of an option that was granted to a grantee and is subject to or
became subject to this Subtopic shall be included in the determination of net income. (See paragraphs 815-10-
55-46 through 55-48A and 815-10-55-54 through 55-55 for discussion of such an option.) Changes in fair
value of the option award before vesting shall be characterized as compensation cost in the grantor’s income
statement. Changes in fair value of the option award after vesting may be reflected elsewhere in the grantor’s
income statement.
Equity Options Issued to Employees and Nonemployees

55-46 Some entities issue stock options to grantees in which the underlying shares are stock of an unrelated
entity. Consider the following example:
a. Entity A awards an option to a grantee.
b. The terms of the option award provide that, if the grantee continues to provide services to Entity A for 3
years, the grantee may exercise the option and purchase 1 share of common stock of Entity B, a publicly
traded entity, for $10 from Entity A.
c. Entity B is unrelated to Entity A and, therefore, is not a subsidiary or accounted for by the equity method.
32
Chapter 2 — Scope
55-47 The option award in this example is not within the scope of Topic 718 because the underlying stock is
not an equity instrument of the grantor.
55-48 The option award is not subject to Topic 718. Rather, the option award in the example in paragraph
815-10-55-46 meets the definition of a derivative instrument in this Subtopic and, therefore, should be
accounted for by the grantor as a derivative instrument under this Subtopic. After vesting, the option award
would continue to be accounted for as a derivative instrument under this Subtopic.
Stock options that are indexed to and settled in shares of an unrelated publicly traded entity are outside
the scope of ASC 718. Such options are recorded at fair value5 as liabilities at inception, with changes
in fair value recorded in earnings. If the options are indexed to and settled in shares of an unrelated
non-publicly-traded entity, the same accounting applies by analogy6 to ASC 815-10-45-10 and ASC
815-10-55-46 through 55-48. In addition, EITF Issue 08-8 states, in part:
The SEC Observer reiterated the SEC staff’s longstanding position that written options that do not qualify for
equity classification should be reported at fair value and subsequently marked to fair value through earnings.
ASC 815-10-45-10 requires that the entire change in fair value of the stock options before vesting be
immediately characterized as compensation cost; however, changes in fair value after vesting may be
reflected elsewhere in the entity’s income statement. ASC 815-10-45-10 and ASC 815-10-55-46 through
55-48 do not provide guidance on accounting for the corresponding debit associated with recognition of
the entire derivative liability that will be recorded as of the issuance date of the stock options. However,
ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48 imply that these stock options are considered
compensation to grantees; therefore, the initial debit upon recording the stock options at fair value
is a prepaid compensation asset, with attribution of the issuance-date fair value recognized over the
requisite service period. The prepaid compensation asset is not adjusted for subsequent changes in the
fair value of the stock options. That is, any changes made to the fair value after the initial measurement
of the prepaid compensation asset will not be reflected as additional prepaid compensation but
will instead be recognized immediately as an expense (either compensation cost for changes in the
fair value of the award before vesting or classification as something other than compensation cost
for changes in the fair value of the award after vesting), with a corresponding debit or credit to the
derivative liability.
The guidance above also applies to restricted stock that is indexed to and settled in shares of an
unrelated entity.
5
Because the stock options are not within the scope of ASC 718, “fair value” in this context refers to fair value as determined in accordance with
ASC 820, not to fair-value-based measurement under ASC 718.
6
In this scenario, an entity should apply ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48 to the stock options by analogy rather than
directly because the stock options involve an underlying that is a non-publicly-traded share of an unrelated entity, while the stock options in ASC
815-10-45-10 and ASC 815-10-55-46 through 55-48 involve an underlying that is a publicly traded share of an unrelated entity (and that therefore
meets the definition of a derivative, since it can be net settled in accordance with ASC 815-10-15-83). Often, option awards on non-publicly-traded
shares of an unrelated entity will not meet the net settlement criteria of ASC 815-10-15-83 because of the lack of (1) explicit net settlement,
(2) a market mechanism to net settle the options, and (3) delivery of shares that are readily convertible to cash (since the shares are not publicly
traded). However, because there is no specific guidance in the accounting literature on accounting for stock options that are indexed to and
settled in shares of an unrelated non-publicly-traded entity, the fair value accounting in ASC 815-10-45-10 and ASC 815-10-55-46 through 55-48
is appropriate by analogy (since the stock options are outside the scope of ASC 718, as discussed above), even though they do not meet the
definition of a derivative in ASC 815.
33
Example 2-5
On January 1, 20X1, Entity A issues restricted stock to an employee. The terms of the award indicate that if
the employee remains employed by A for three years, the employee will receive 20 shares of common stock
of Entity B, an unrelated publicly traded entity, from A. The fair value of the award on January 1, 20X1, and
December 31, 20X1, was $300 and $325, respectively. The following journal entries reflect the accounting for
the award:
Journal Entry: January 1, 20X1
Prepaid compensation asset 300

Derivative liability 300
To record the issuance of the restricted stock award.
Journal Entries: December 31, 20X1
Compensation cost 100

To record the amortization of the prepaid compensation asset on a
straight-line basis over the three-year service period.
Compensation cost* 25
To record the change in the derivative liability’s fair value.
* In accordance with ASC 815-10-45-10, changes in the fair value of the award before vesting should be characterized
as compensation cost in the entity’s income statement; however, changes in the fair value of the award after vesting
may be reflected elsewhere in the entity’s income statement.
Because instruments that are indexed to and settled in shares of an unrelated entity and that are issued
to grantees for goods or services are not within the scope of ASC 718, entities are not permitted to
account for forfeitures of these instruments in accordance with the guidance on share-based payment
awards in ASC 718. The likelihood that the grantees will forfeit the awards is factored into the fair value
measurement7 of such instruments at the end of each reporting period.
Example 2-6
On January 1, 20X1, Entity A issues restricted stock to an employee. The terms of the award indicate that if
the employee remains employed by A for three years, the employee will receive 20 shares of common stock
of Entity B, an unrelated publicly traded entity, from A. The fair value of the award on January 1, 20X1, and
December 31, 20X1, was $300 and $325, respectively. On January 1, 20X2, the employee resigns and forfeits
the award. The following journal entries reflect the accounting for the award:

Derivative liability* 300
To record the issuance of the restricted stock award.
7
Because the instruments are not within the scope of ASC 718, “fair value” in this context refers to fair value as determined in accordance with ASC
820, not to fair-value-based measurement under ASC 718.
34
Chapter 2 — Scope
Example 2-6 (continued)

To record the amortization of the prepaid compensation asset on a
straight-line basis over the three-year service period.
Compensation cost** 25
Derivative liability* 25
To record the change in the derivative liability’s fair value.
Journal Entries: January 1, 20X2

To expense the remaining portion of the prepaid compensation
asset.

Because the employee has resigned, the fair value of the derivative
instrument is $0. This entry is to remove the derivative liability.
* The likelihood that the employee will forfeit the award is factored into the fair value measurement of the instrument.
** In accordance with ASC 815-10-45-10, changes in the fair value of the award before vesting should be characterized as
compensation cost in the entity’s income statement; however, changes in the fair value of the award after vesting may be
reflected elsewhere in the entity’s income statement.
2.12 Escrowed Share Arrangements

ASC 718-10 — SEC Materials — SEC Staff Guidance
SEC Staff Announcement: Escrowed Share Arrangements and the Presumption of Compensation
S99-2 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.FN1
Under these arrangements, which can be between shareholders and a company or directly between the shareholders
FN1
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.
35
ASC 718-10 — SEC Materials — SEC Staff Guidance (continued)
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.FN2, 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).
The SEC staff notes that discounts on debt instruments are amortized using the effective interest method as discussed in
FN2
Section 835-30-35, while discounts on common equity are not generally amortized.
Consistent with the views in paragraph 220-10-S99-4, SAB Topic 5.T., Accounting for Expenses or Liabilities Paid by
FN3
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.
As part of completing an IPO or other financing, certain shareholders who are also key employees of an
entity may agree to place in escrow a portion of their shares, which would be released to them upon
the satisfaction of a specified condition. In many of these arrangements, the shares are released only
if the employee shareholders remain employed for a certain period or the entity achieves a specified
performance target, and services from the employee shareholders may be explicitly stated in the
arrangement or implicitly required in accordance with a performance target.
As indicated in ASC 718-10-S99-2, the SEC staff has historically expressed the view that escrowed share
arrangements such as these are presumed to be compensatory and equivalent to reverse stock splits
followed by the grant of restricted stock, subject to certain conditions (e.g., service, performance, or
market conditions). If the release of shares is tied to continued employment, the presumption cannot
be overcome. In addition, even if the entity is not directly a party to the arrangement (e.g., when the
arrangement is only between shareholders and new investors), the arrangement should be reflected in
the entity’s financial statements.
However, the SEC staff has stated that in certain circumstances, the presumption can be overcome
that an arrangement is compensation. To identify those circumstances, an entity should assess the
substance of the escrowed share arrangement to determine whether it was “entered into for purposes
unrelated to, and not contingent upon, continued employment.” For example, as a result of concerns
related to the entity’s value, investors may require certain shareholders to participate in an escrowed
share arrangement before the entity can raise financing. Further, investors may require the entity
to achieve certain performance targets (e.g., an EBITDA target over a specified period) before the
shares can be released. If the arrangement also requires continued employment, the arrangement
is considered compensatory. However, if continued employment is not required (either explicitly or
implicitly), the entity should consider all relevant facts and circumstances to determine whether the
substance of the arrangement is unrelated to employee compensation.
36
Chapter 3 — Recognition
3.1 General Recognition Principles

ASC 718-10
Recognition Principle for Share-Based Payment Transactions

25-2 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 718-10-25-2A
through 25-2B. 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).
25-2A 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.
25-2B 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.
25-2C 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.
A share-based payment arrangement is an exchange between an entity and a grantee who provides
goods or services. The entity recognizes the effect of that exchange in the balance sheet and income
statement as goods are delivered or services are rendered. The share-based payment transaction is
measured on the basis of the fair value (or sometimes the calculated or intrinsic value) of the equity
instrument issued. While an entity uses the fair-value-based measurement method in ASC 718 to
determine the value of a share-based payment, that method does not take into account the effects of
37
vesting conditions and other types of features that would be included in a true fair value measurement.
The objectives of accounting for equity instruments issued to grantees are to (1) measure the cost of
the goods or services received (i.e., compensation cost) in exchange for an award of equity instruments
on the basis of the fair-value-based measure of the award on the grant date and (2) recognize that
measured compensation cost in the financial statements over the requisite service period or the
nonemployee’s vesting period. Note that the term “nonemployee’s vesting period” as used throughout
ASC 718 and this publication is intended to represent the recognition of compensation cost for a
nonemployee award 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 the share-based payment award.
The classification of the award dictates the corresponding credit in the balance sheet and affects the
amount of compensation cost recognized over the requisite service or the nonemployee’s vesting
period. If the award is classified as equity, the corresponding credit is recorded in equity — typically as
paid-in capital. If the award is classified as a liability, the corresponding credit is recorded as a share-
based liability. Equity-classified awards are generally recognized as compensation cost over the requisite
service or nonemployee’s vesting period on the basis of the fair-value-based measure of the award
on the grant date. On the other hand, liability-classified awards are remeasured at their fair-value-
based amount in each reporting period until settlement. That is, the changes in the fair-value-based
measure of the liability at the end of each reporting period are recognized as compensation cost, either
immediately or over the remaining requisite service period or nonemployee’s vesting period, depending
on the vested status of the award. See Chapter 7 for a discussion of the differences between the
accounting for equity-classified awards and that for liability-classified awards.
Like other compensation costs (e.g., cash compensation), those associated with share-based payment
awards are usually recognized as an expense. In some instances, such costs may be capitalized as part
of an asset and later recognized as an expense. For example, if a grantee’s compensation is included in
the cost of acquiring or constructing an asset, the compensation cost arising from share-based payment
awards would be capitalized in the same manner as cash compensation. The capitalized compensation
cost would subsequently be recognized as cost of goods sold or as depreciation or amortization
expense.
3.2 Determining the Grant Date

Grant Date
The date at which a grantor and a grantee reach a mutual understanding of the key terms and conditions of
a share-based payment award. The grantor becomes contingently obligated on the grant date to issue equity
instruments or transfer assets to a grantee who delivers goods or renders services or purchases goods or
services as a customer. 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),
for example, if management and the members of the board of directors control enough votes to approve the
arrangement. Similarly, individual awards that are subject to approval by the board of directors, management,
or both are not deemed to be granted until all such approvals are obtained. The grant date for an award of
equity instruments is 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. Paragraph 718-10-25-5 provides guidance on determining
the grant date. See Service Inception Date.
38
ASC 718-10
Determining the Grant Date

25-5 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 718-10-55-80 through 55-83.
Determination of Grant Date

55-80 This guidance expands on the guidance provided in paragraph 718-10-25-5.
55-81 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.
55-82 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.
55-83 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.
39
Generally, compensation cost is recognized over the requisite service period or nonemployee’s vesting
period on the basis of the fair-value-based measure of the share-based payment award on the grant
date (see Section 3.6 for a discussion of the requisite service period and Section 9.3 for a discussion of
the nonemployee’s vesting period). The exchange between the entity and the grantee of share-based
payments for goods or services begins on the service inception date (which is defined as the date
on which the requisite service period or nonemployee’s vesting period begins). The service inception
date is typically the grant date; however, it may precede the grant date if certain conditions are met.
Accordingly, an entity may begin to recognize compensation cost before the grant date. (See Section
3.6.4 for a discussion of the conditions that must be met for the service inception date to precede the
grant date for an employee award.)
For a grant date to be established, all of the following conditions must be met:
• The entity and grantee have reached a mutual understanding of the key terms and conditions of
the award.
• The grantee begins to benefit from, or be adversely affected by, subsequent changes in the
price of the entity’s equity shares for equity instruments. See Section 3.2.4 for a discussion of
establishing a grant date in situations in which the exercise price is unknown. See Section 3.2.6
for a discussion of establishing a grant date for awards to be settled in a variable number of
shares.
• All necessary approvals have been obtained. Awards issued under a share-based payment
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). For example, if
shareholder approval is required but management or the members of the board of directors
control enough votes to approve the arrangement, shareholder approval is essentially a
formality or perfunctory. Individual awards that are subject to approval by the board of directors,
management, or both, are not considered granted until all such approvals are obtained. See
Section 3.2.1 for a discussion of establishing a grant date in situations in which the awards are
subject to approval by the entity’s shareholders, board of directors, or both.
• For employee awards, the recipient must meet the definition of an employee. See ASC
718-10-20 for the definition of an employee and Section 2.2 for a discussion of the definition
of a common law employee. Irrespective of the employment contract grant date (agreed upon
between an employer and future employee), the grant date and the service inception date, as
described at Section 3.6.4, cannot occur until employee services are provided as illustrated in
Example 3-1.
Although formal, written agreements (e.g., plan documents, award agreements, or employment
agreements) provide the best evidence of the key terms of an arrangement, oral arrangements or
past practice may also establish key terms and, in some instances, may suggest that the substantive
arrangement differs from the written arrangement. For example, if the written terms of a share-based
payment plan provide for settlement in stock but the entity has historically settled awards in cash,
that past practice may suggest that the arrangement should be accounted for as being settled in cash
and should therefore be classified as a liability award, despite the terms established in the written
arrangement. In addition, if all of the conditions for establishing a grant date have been met, a grant
date has been established for accounting purposes even if the written terms of a share-based payment
state that such a date is in the future. Similarly, unless all of the conditions for establishing a grant date
have been met, a grant date has not been established for accounting purposes even if the written terms
of a share-based payment state that such a date has been established.
40
See the following for additional discussions of reaching a mutual understanding of key terms and
conditions:
• Section 3.2.2 — Award in which the approval date precedes the communication date.
• Section 3.2.3 — Award in which the vesting conditions are unknown.
• Section 3.2.5 — Award in which a discretionary provision is included in the terms of the award.
Example 3-1
On January 1, 20X1, an individual is issued stock options upon signing an employment agreement. The options
vest at the end of the third year of service on December 31, 20X3 (cliff vesting). However, the individual does
not begin to work (i.e., provide service in exchange for the options) for the entity until February 15, 20X1, and
therefore does not meet the definition of an employee before this date. Accordingly, provided that all other
conditions for establishing a grant date have been met, the grant date does not occur until February 15, 20X1.
Compensation cost would be determined on the basis of the fair-value-based measure of the options on
February 15, 20X1. Because the service inception date cannot begin before the individual provides service to
the entity, compensation cost is recognized ratably over the period from February 15, 20X1, through December
31, 20X3.
3.2.1 Approval
When share-based payment awards are subject to approval by an entity’s shareholders, board of
directors, or both, generally a grant date is not established before such approval is granted. Before
establishing a grant date for a share-based payment transaction with a grantee, an entity generally
must obtain all necessary approvals unless such approvals are essentially perfunctory or a formality.
Accordingly, unless management (1) controls enough votes to ensure shareholder approval (when
shareholder approval is required) or controls the board of directors (when board approval is required)
and (2) has approved the awards, a grant date has not been established until the necessary approvals
have been obtained and all other grant-date conditions have been met.
In most cases, the key terms and conditions of awards are determined by the issuing entity’s
management and approved by the board of directors (or the compensation committee of the board
of directors). A grantee’s failure to formally accept the award may not preclude the grant date from
being established. However, if a grantee is in a position to negotiate the key terms and conditions of its
awards, a grant date cannot occur until both parties agree on those terms and conditions.
Example 3-2
On January 1, 20X1, Entity A’s management approves the issuance of 1,000 shares of restricted stock to an
executive (all terms are known and communicated to the executive) in accordance with A’s executive stock
incentive plan. The terms of the plan require A’s board of directors to approve all individual awards, and
management does not control the board. However, on the basis of past practice, it is reasonably likely that the
board will approve the award.
The board meets on March 1, 20X1, and approves the award. Therefore, if all other conditions for establishing
a grant date have been met, the grant date would be March 1, 20X1. Note that even though it is likely that
approval will be granted, this does not affect the determination of whether an approval is perfunctory and,
therefore, of whether a grant date can be established before such approval is obtained. Rather, the approval in
this example would not be considered perfunctory because management does not control the outcome of the
board’s vote.
41
Example 3-3
Entity A’s board of directors has formally delegated to management the right to grant share-based payment
awards to employees when certain conditions are met. On February 1, 20X1, A’s management approves
and communicates the award of 100 stock options to a newly hired employee (all terms are known and the
employee begins working for A on February 1, 20X1). Because the board has delegated to management the
responsibility of granting awards, the board does not need to provide further approval for the award. However,
at its March 1, 20X1, meeting, the board acknowledges, in the minutes to the board meeting, the award that
was granted by management on February 1, 20X1.
If all other conditions for establishing a grant date have been met, the grant date would be February 1, 20X1,
since board approval is not required (it was merely “acknowledged” in the minutes to the board meeting), and
A’s management was given the authority to award the stock options. However, A should exercise caution in
determining the grant date whenever board approval is subsequently obtained, even when it is not required.
3.2.2 Communication Date
A grant date may be established on the approval date if that date precedes the date on which the award
is communicated to the recipient (i.e., the communication date). ASC 718-10-25-5 provides a practical
accommodation for determining a grant date and states that as long as all other criteria for establishing
a grant date have been met, a mutual understanding, and therefore a grant date, is presumed to exist
on the date the award is approved in accordance with the relevant corporate governance requirements
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.
The definition of a “relatively short time period” is a matter of professional judgment and depends on
how an entity communicates the terms and conditions of its awards to its grantees. For example, if
an entity communicates the terms and conditions of its awards via an employee benefits Web site or
by e-mail, a relatively short time period may be a few days or the amount of time it would reasonably
take to post the information on the Web site and communicate to the grantees that the information is
available. On the other hand, if the terms and conditions of the awards are usually communicated to
each grantee individually, the relatively short time period may be a few weeks.
If the approval date is considered to be the grant date pursuant to ASC 718-10-25-5, any change in the
terms or conditions of the award between the approval date and the communication date should be
accounted for as a modification of the award in accordance with ASC 718-20-35-2A through 35-4. See
Chapter 6 for examples of the accounting for the modification of a share-based payment award.
42
3.2.3 Unknown Conditions
ASC 718-10
Example 3: Employee Share-Based Payment Award With a Performance Condition and Multiple Service
Periods
55-92 The following Cases illustrate employee share-based payment awards with a performance condition (see
paragraphs 718-10-25-20 through 25-21; 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).
55-93 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.
Case A: Performance Targets Are Set at the Inception of the Arrangement

55-94 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.
Case B: Performance Targets Are Established at Some Time in the Future

55-95 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.
The key differences between Case A and Case B in ASC 718-10-55-94 and 55-95 are related to when
a mutual understanding of key terms and conditions has been established. The entity in Case A
established performance conditions with the CEO when both parties entered the arrangement, which
resulted in the establishment of a grant date at the inception of the award arrangement. The award
will have four independent tranches with four separate inception dates, but the fair value of the entire
award will be established on the grant date (i.e., January 1, 20X5). In Case B, a mutual understanding
of key terms and conditions has not been established at the time both parties entered into the
arrangement because the performance conditions associated with the award granted have not been
established. The performance conditions will be established at the beginning of each year. Therefore,
43
each of the four vesting tranches of the award will have its own service inception date and grant date at
the time a performance condition is established for each tranche. In other words, the awards in Case B
will have different fair values established for each vesting tranche.
Accordingly, all the key terms and conditions of the award must be known, including any vesting
conditions (i.e., service or performance conditions) or market conditions. In addition, if the vesting or
market conditions are too subjective or discretionary, the terms and conditions of the award may not be
mutually understood (see Example 3-5).
Example 3-4
On January 1, 20X1, Entity A issues 1,000 shares of restricted stock to its employees. The shares will vest in 25
percent increments (tranches) each year over the next four years if A’s actual earnings for each year exceed
its annual budgeted earnings by 10 percent (i.e., a graded vesting schedule). Entity A set its annual budget in
November of the previous year.
In this scenario, a grant date has been established for only 250 of the shares on January 1, 20X1 (all other
conditions for establishing a grant date must also be met). A grant date has not been established for the other
750 shares because the performance conditions for the shares have not been established yet. The grant dates
for those shares will occur once A’s annual budget for the appropriate year has been established and the
employee is aware of the performance target (or the performance target is communicated to the employee
within a “relatively short time period” thereafter in accordance with ASC 718-10-25-5). Accordingly, the grant
dates will most likely be January 1, 20X1, for the first tranche of 250 shares; November 20X1 for the second
tranche of 250 shares; November 20X2 for the third tranche of 250 shares; and November 20X3 for the last
tranche of 250 shares.
Example 3-5
On January 1, 20X1, Entity A issues 1,000 employee stock options. The options vest at the end of one year
of service but only if the employee receives a performance rating of at least 4. Performance ratings are
established at the end of the year on a scale of 1 through 5 (with 5 being the highest).
In this scenario, whether a grant date has been established on January 1, 20X1, depends on the facts and
circumstances. Generally, if performance conditions are too subjective or discretionary, there is a lack of mutual
understanding of the key terms and conditions of the award and, therefore, no grant date is established. If a
performance condition is based on individual performance evaluations, an entity may consider the following
items, among others, in determining whether it can be objectively established that the performance condition
has been met (i.e., whether there has been a mutual understanding of the key terms and conditions):
• Whether there is a well-established, rigorous system for performance evaluations.

• Whether there are objective goals and specific criteria in place.
• Whether, in addition to determining vesting of share-based payment awards, the evaluations are used
for other purposes (e.g., annual raises, promotions).
• Whether overall evaluations are subject to requirements that force a specific distribution (e.g., a rating of
5 is limited to a specified percentage of employees within the group).
• Whether evaluations are completed by direct supervisors.
44
An award may contain a performance condition or market condition whose achievement depends on
future events that are not within the control of the issuing entity. For example, to satisfy a performance
condition, an entity may have to attain an EPS growth rate that outperforms the average EPS growth rate
of a peer group in the same industry. Unlike the scenario in Example 3-4, the fact that the entity and
grantee do not know the EPS growth rate that the peer group will achieve does not prevent them from
mutually understanding the award’s key terms and conditions. For a grant date to be established, the
performance condition or market condition must be objectively determinable and nondiscretionary.
Example 3-5A
On November 1, 20X1, Entity B issues RSUs to Employee E. The RSUs will vest in 1,000 shares of common
stock if (1) B’s stock price increases 15 percent from January 1, 20X2, to December 31, 20X2, and (2) E is still
employed on December 31, 20X2.
As of November 1, 20X1, E understands what stock price increase must be achieved to earn the award relative
to the stock price as of January 1, 20X2. Accordingly, on November 1, 20X1, a grant date may be established
even if the stock price on January 1, 20X2, is unknown when the RSUs are issued because the market condition
is objectively determinable and nondiscretionary.
3.2.4 Unknown Exercise Price

ASC 718-10
Example 4: Employee Share-Based Payment Award With a Service Condition and Multiple Service Periods
55-97 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).
Case A: Exercise Price Established at Subsequent Dates

55-98 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 718-10-55-80 through 55-83
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.
45
The conclusion in Case A above is that the stock options granted to the chief executive officer will have
five separate grant dates established on December 31 of each year. The grant date for each tranche
is December 31 of each year because that is when the exercise price will be known for the fully vested
stock options that are annually awarded to the chief executive officer. Accordingly, December 31 is the
date on which there is a mutual understanding of key terms and conditions (provided that all other
terms and conditions are known) between the grantee (i.e., the chief executive officer) and the grantor
(i.e., the entity). In addition to their five separate grant dates, the fully vested stock options have five
separate service inception dates, which are one year before each grant date. Accordingly, in such
situations, the entity may be required to begin recognizing compensation cost before the grant date.
From the service inception date until the grant date, the entity remeasures the options at their fair-
value-based measure at the end of each reporting period on the basis of the assumptions that exist
on those dates. Once the grant date is established, the entity discontinues remeasuring the options
at the end of each reporting period. That is, the final measure of compensation cost is based on the
fair-value-based measure on the grant date. (See Section 3.6.4 and Example 6 in ASC 718-10-55-107
through 55-115 for a discussion and examples of the conditions that must be met for a service inception
date to precede the grant date.) Since each tranche has a separate grant date at one-year intervals and
separate service inception dates at one-year intervals, the grantor does not have the option to apply
either the straight-line attribution method or the accelerated attribution method when recognizing
compensation cost (as discussed in ASC 718-10-35-8) that is associated with the options awarded.
Example 3-6
On January 1, 20X1, Entity A issues 1,000 employee stock options that vest at the end of one year of service (cliff
vesting). All terms of the options are known except for the exercise price, which is set equal to the lower of the
market price of A’s shares on January 1, 20X1, or its market price on December 31, 20X1 (i.e., the employee is
given a look-back option).
In this scenario, a grant date has been established for January 1, 20X1, if all other conditions for establishing a
grant date have also been met. In a manner consistent with ASC 718-10-55-83, while the ultimate exercise price
is not known, it cannot be greater than the current market price of A’s shares. In this case, the relationship
between the exercise price and the current market price of A’s shares constitutes a sufficient basis for
understanding both the compensatory and the equity relationships established by the award. While the
employee may not be adversely affected by any decreases in A’s share price, the employee will begin to benefit
from subsequent increases in the price of A’s shares.
A common issue observed in practice is related to whether a grant date has been established when a
nonpublic entity issues stock options to grantees and the valuation of the entity’s common shares is not
completed until after the issuance date. Generally, the terms of the option agreement require that the
exercise price of the options equal the fair value of a common share of the entity on the issuance date.
To determine the fair value of its common shares, the entity will often hire an independent expert to
perform a valuation of the entity, which will be based solely on information available as of the issuance
date. However, since the valuation is not completed until after the issuance date, the entity may
question whether a grant date has been established for the stock options.
46
An entity’s need to finalize the valuation of the underlying common shares as of a specific date (and
therefore to set the exercise price of the award) would generally not prevent the entity from establishing
a grant date for a share-based payment award with a grantee if all other conditions for establishing
a grant date have been met. The result of the valuation, based solely on information available as of
the issuance date, should be identical, regardless of whether the valuation work is completed on the
issuance date (i.e., all of the work is hypothetically performed instantaneously) or as of a subsequent
date.
One factor that could cause uncertainty about whether a grant date is established is the amount of
time it takes, after the issuance of the award, to complete the valuation. A lengthy period between the
purported valuation date and the completion of the valuation work may call into question whether an
entity has used hindsight in selecting the underlying assumptions. Note that even if the final valuation
is completed after the grant date, an entity is required to use the information available as of the
established grant date. In other words, to prevent biased estimates, an entity should not factor hindsight
into the valuation.
Note also that if an entity were to change the original terms of the award after the established grant
date but before completion of the valuation, the entity would account for the changes as a modification.
See Chapter 6 for a discussion of the accounting for a modification of a share-based payment award.
3.2.5 Discretionary Provisions
If an entity that issues share-based payment awards can, in the future, exercise discretion regarding any
of the key terms or conditions that were established when the awards were issued, a grant date may
not have been established. The existence of such discretion may indicate uncertainty about whether a
mutual understanding of the key terms and conditions was reached. For example, specific and objective
performance metrics for determining vesting could be established when the awards were issued,
but the entity may have discretion to adjust the performance metrics or the items that comprise the
performance metrics at the end of the performance period. If there are few or no limitations on when
and how such adjustments are to be made, a grantee may not have a sufficient understanding of the
performance condition (i.e., the vesting condition) because the entity at its discretion could adjust it at
the end of the performance period. By contrast, the existence of a provision that requires specific and
objective adjustments to be made upon the occurrence of stated triggering events would most likely
not, by itself, indicate that the key terms and conditions of the award are uncertain. A determination of
whether a grantee sufficiently understands the award’s key terms and conditions should be based on
the facts and circumstances (e.g., past practice, other communications).
In addition, an award may contain a clawback provision that gives the entity discretion to determine how
much of the award is returned if the clawback provision is violated (e.g., a noncompete or nonsolicitation
provision is violated). Even if the event or events that trigger the clawback provision are objective and
specific, the entity should evaluate whether its ability to determine the amount subject to the clawback is
a “key” term or condition that might affect whether a mutual understanding is reached.
A “negative-discretion” provision is a common feature of share-based payment plans that allows

management or the board of directors to reduce the number of awards due to a grantee. For example,
a plan might state that 100 awards will be earned if EBITDA increases by at least 10 percent each
year over a three-year period, with more or fewer awards issued for performance above or below
that threshold. A negative-discretion provision would give management or the board of directors the
discretion to reduce the number of awards below the amount determined by the plan’s stated terms at
the end of the performance period.
47
Entities must carefully consider whether a negative-discretion provision in a share-based payment plan
will preclude the entity from establishing a grant date under ASC 718 until management or the board
of directors determines the number of awards due to a grantee at the end of the performance period.
Since a criterion for establishing a grant date for a share-based payment transaction with a grantee is
that the entity and grantee reach a mutual understanding about the key terms and conditions of the
share-based payment award, entities should consider whether a plan’s negative-discretion provision is a
“key” term or condition that could result in uncertainty in the number of awards to be earned. Factors to
consider, among others, include the following:
• Management’s intent and the purpose of the provision, including circumstances in which
management believes it will exercise its right under the negative-discretion provision.
• Whether, in the past, management has exercised its right under the negative-discretion
provision.
• Frequency of use of the negative-discretion provision, including when it was used and the
reasons for using it.
• Grantees’ awareness of the negative-discretion provision. All communications to grantees,

including verbal representations, should be considered.
Example 3-7
An employee is awarded 100 shares of restricted stock on January 1, 20X7. The shares vest on the basis of
a service condition and a performance condition. While both the service and performance conditions have
been specified, management retains the discretion to increase or decrease the number of shares that vest by
up to 25 percent on the basis of the entity’s performance. Management has not provided guidance on what
performance criteria would trigger the use of discretion. Furthermore, management has previously exercised
discretion provisions for similar share-based payment awards granted to employees.
The discretion provision will not affect the entity’s ability to establish a grant date for the 75 percent of shares
that are not subject to the discretion provision and, if all the other criteria for establishing a grant date have
been met, a grant date has been established on January 1, 20X7, for these 75 shares. However, for the
remaining 25 percent of shares that are subject to the discretion provision, these 25 shares do not have the
same terms and conditions as the other 75 shares. Thus, the entity should separately evaluate the 25 shares
subject to the discretion provision to determine whether the discretion provision for those shares affects the
entity’s ability to establish a grant date (a grant date has most likely not been established for the 25 shares).
3.2.6 Awards Settled in a Variable Number of Shares

As Chapter 5 discusses in more detail, while share-based payment awards subject to ASC 718 are
outside the scope of ASC 480, ASC 718-10-25-7 requires entities to apply the classification criteria in
ASC 480-10-25 and in ASC 480-10-15-3 and 15-4 unless ASC 718-10-25-8 through 25-19A require
otherwise. As a result, certain awards may be classified as a liability because an entity has an obligation
to issue a variable number of shares that are based on a fixed monetary amount known at inception.
In this circumstance, the grantee will not begin to benefit from, or be adversely affected by, subsequent
changes in the price of the entity’s equity shares until the number of shares is determined. However,
because the liability is based on a fixed amount, we do not believe that the ability to benefit from, or
be adversely affected by, subsequent changes in the price of the entity’s equity shares is necessary
to establish a grant date. Thus, if all other grant date criteria have been met, an entity would not be
precluded from establishing a grant date for share-based liabilities that are based on a fixed monetary
amount known at inception.
48
3.3 Nonvested Shares Versus Restricted Shares

Nonvested Shares
Shares that an entity has not yet issued because the agreed-upon consideration, such as the delivery
of specified goods or services and any other conditions necessary to earn the right to benefit from the
instruments, has not yet been satisfied. Nonvested shares cannot be sold. The restriction on sale of nonvested
shares is due to the forfeitability of the shares if specified events occur (or do not occur).
Restricted Share
A share for which sale is contractually or governmentally prohibited for a specified period of time. Most grants
of shares to grantees are better termed nonvested shares because the limitation on sale stems solely from
the forfeitability of the shares before grantees have satisfied the service, performance, or other condition(s)
necessary to earn the rights to the shares. Restricted shares issued for consideration other than for goods or
services, on the other hand, are fully paid for immediately. For those shares, there is no period analogous to
an employee’s requisite service period or a nonemployee’s vesting period during which the issuer is unilaterally
obligated to issue shares when the purchaser pays for those shares, but the purchaser is not obligated to
buy the shares. The term restricted shares refers only to fully vested and outstanding shares whose sale is
contractually or governmentally prohibited for a specified period of time. Vested equity instruments that are
transferable to a grantee’s immediate family members or to a trust that benefits only those family members are
restricted if the transferred instruments retain the same prohibition on sale to third parties.
A nonvested share is an award that a grantee earns once the grantee has provided the requisite goods
or services as specified under the terms of the share-based payment arrangement (i.e., once the vesting
conditions are met). For example, a grantee may be issued shares of common stock but may not be able
to retain the shares unless the grantee provides three years of service (service condition) and revenue
has grown by a specified percentage during that three-year period (performance condition). If the
grantee fails to provide the required three years of service, or the revenue growth target is not met, the
shares would be forfeited to the entity.
While a nonvested share is often referred to as “restricted stock,” it should not be confused with
restricted shares, which ASC 718-10-20 defines as “fully vested and outstanding shares whose sale is . . .
prohibited for a specified period of time.” For example, a grantee may be issued a fully vested share but
may be restricted from selling it for a two-year period. If the grantee ceases to provide goods or services
before the end of the two-year period, the grantee retains the share. However, the grantee’s ability to
sell the share remains contingent on the lapse of the two-year period.
When determining a share-based payment award’s fair-value-based measure, an entity should generally
consider restrictions that are in effect after a grantee has vested in the award, such as the inability to
transfer or sell vested shares for a specified period. This restriction may result in a discount relative to
the fair-value-based measure of the shares without a postvesting restriction. See Section 4.8.
49
3.4 Vesting Conditions
Vest
To earn the rights to. A share-based payment award becomes vested at the date that the grantee’s right to
receive or retain shares, other instruments, or cash under the award is no longer contingent on satisfaction of
either a service condition or a performance condition. Market conditions are not vesting conditions.
The stated vesting provisions of an award often establish the employee’s requisite service period or the
nonemployee’s vesting period, and an award that has reached the end of the applicable period is vested.
However, as indicated in the definition of requisite service period and equally applicable to a nonemployee’s
vesting period, the stated vesting period may differ from those periods in certain circumstances. Thus, the
more precise terms would be options, shares, or awards for which the requisite good has been delivered
or service has been rendered and the end of the employee’s requisite service period or the nonemployee’s
vesting period.
ASC 718-10
55-7 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 718-10-55-64 through 55-66).
Market, Performance, and Service Conditions That Affect Vesting and Exercisability
55-60 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.
Share-based payment awards may contain the following types of conditions that affect the vesting,
exercisability, or other pertinent factors of the awards:
• Service conditions (e.g., the award vests upon the completion of four years of continued service).
• Performance conditions (e.g., the award vests when a specified amount of the entity’s product is
sold).
• Market conditions (e.g., the award becomes exercisable when the market price of the entity’s
stock reaches a specified level).
• Other conditions (those that affect an award’s vesting, exercisability, or other factors relevant to
the fair-value-based measurement that are not market, performance, or service conditions).
Service and performance conditions may be considered vesting conditions. That is, the service or
performance condition must be satisfied for a grantee to earn (i.e., vest in) an award. Compensation
cost is recognized only for awards that are earned or expected to be earned, not for awards that are
forfeited or expected to be forfeited because a service or performance condition is not met.
50
Some awards may contain a market condition. Unlike a service or performance condition, a market
condition is not a vesting condition. Rather, a market condition is directly factored into the fair-value-
based measure of an award. Accordingly, regardless of whether the market condition is satisfied, an
entity would still be required to recognize compensation cost for the award if the service is rendered or
the good is delivered (i.e., the service or performance condition is met).
ASC 718-10-25-13 specifies that awards 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 should be classified
as a liability, and the additional factor (often referred to as an “other condition”) should be incorporated
into the estimate of the fair-value-based measure of the award. See Sections 4.6.2 and 5.5 for additional
information about other conditions.
3.4.1 Service Condition

Service Condition
A condition affecting the vesting, exercisability, exercise price, or other pertinent factors used in determining
the fair value of an award that depends solely on an employee rendering service to the employer for the
requisite service period or a nonemployee delivering goods or rendering services to the grantor over a vesting
period. A condition that results in the acceleration of vesting in the event of a grantee’s death, disability, or
termination without cause is a service condition.
ASC 718-10
35-3 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.
55-5 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).
51
55-6 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.
ASC 718-20
Example 8: Employee Share Award Granted by a Nonpublic Entity

55-71 The Example illustrates the guidance in paragraphs 718-10-30-17 through 30-19 and 718-740-25-2
through 25-4 for employee awards. The accounting demonstrated in this Example also would be applicable to a
public entity that grants share awards to its employees. The same measurement method and basis is used for
both nonvested share awards and restricted share awards (which are a subset of nonvested share awards).
55-72 On January 1, 20X6, Entity W, a nonpublic entity, grants 100 shares of stock to each of its 100 employees.
The shares cliff vest at the end of three years. Entity W estimates that the grant-date fair value of 1 share of
stock is $7. The grant-date fair value of the share award is $70,000 (100 × 100 × $7). The fair value of shares,
which is equal to their intrinsic value, is not subsequently remeasured. For simplicity, the example assumes
that no forfeitures occur during the vesting period. Because the requisite service period is 3 years, Entity W
recognizes $23,333 ($70,000 ÷ 3) of compensation cost for each annual period as follows.
Compensation cost $23,333

Additional paid-in capital $23,333
To recognize compensation cost.
Deferred tax asset $8,167

Deferred tax benefit $8,167
To recognize the deferred tax asset for the temporary difference
related to compensation cost ($23,333 × .35 = $8,167).
55-73 After three years, all shares are vested. For simplicity, this Example assumes that no employees made an
Internal Revenue Service (IRS) Code §83(b) election and Entity W has already recognized its income tax expense
for the year in which the shares become vested without regard to the effects of the share award. (IRS Code
§83(b) permits an employee to elect either the grant date or the vesting date for measuring the fair market
value of an award of shares.)
55-74 The fair value per share on the vesting date, assumed to be $20, is deductible for tax purposes.
Paragraph 718-740-35-2 requires that the tax effect be recognized as income tax expense or benefit in the
income statement for the difference between the deduction for an award for tax purposes and the cumulative
compensation cost of that award recognized for financial reporting purposes. With the share price at $20 on the
vesting date, the deductible amount is $200,000 (10,000 × $20), and the tax benefit is $70,000 ($200,000 × .35).
52
55-75 At vesting the journal entries would be as follows.
Deferred tax expense $24,500

To write off deferred tax asset related to deductible share award at
vesting ($70,000 × .35 = $24,500).
Current taxes payable $70,000

Current tax expense $70,000
To adjust current tax expense and current taxes payable to
recognize the current tax benefit from deductible compensation
cost upon vesting of share award.
To satisfy an award’s service condition, the grantee must provide goods or services to the entity for a
specified period. A service condition is typically included explicitly in the terms of an award and is usually
in the form of a vesting condition.
A vesting condition that accelerates vesting of an award upon the death, disability, or termination,
without cause, of the grantee is considered a service condition. However, such a service condition will
have no impact on the requisite service period or the nonemployee’s vesting period until the event that
triggers acceleration becomes probable.
If a grantee forfeits an award with a service condition that affects the award’s vesting and exercisability
(i.e., does not satisfy the service condition), the grantee does not vest in (i.e., has not earned) the award,
and the entity reverses any compensation cost previously recognized during the vesting period. That is,
compensation cost is not recognized for awards that do not vest. Since the service condition affects the
grantee’s ability to earn (i.e., vest in) the award, it is not directly factored into the award’s grant-date fair-
value-based measure. However, a service condition can indirectly affect the grant-date fair-value-based
measure by affecting the expected term of an award that is a stock option. Because an award’s expected
term cannot be shorter than the vesting period, a longer vesting period would result in an increase in
the award’s expected term. See Sections 4.1.1 and 4.6 for a discussion of how a service condition affects
the valuation of share-based payment awards.
ASC 718 allows an entity to make an entity-wide accounting policy election to either (1) estimate
forfeitures when awards are granted (and update its estimate if information becomes available indicating
that actual forfeitures will differ from previous estimates) or (2) account for forfeitures when they occur.
This policy election only applies to forfeitures associated with service conditions, and it can differ for
employee and nonemployee awards. An entity that is contemplating making changes to its accounting
policy for either employee or nonemployee awards must apply ASC 250, including its requirement that
the new recognition policy be preferable to the existing one. See the next section and Section 3.4.1.2 for
examples illustrating the accounting for forfeitures.
53
If an entity adopts a policy to account for forfeitures as they occur, it would still need to estimate
forfeitures when an award is (1) modified (the estimate applies to the original award in the measurement
of the effects of the modification) or (2) exchanged in a business combination (the estimate applies
to the amount attributed to precombination service). However, the accounting policy for forfeitures
will apply to the subsequent accounting for awards that are modified or exchanged in a business
combination. Further, if an entity elects to account for forfeitures when they occur, all nonforfeitable
dividends are initially charged to retained earnings and reclassified to compensation cost only when
forfeitures of the underlying awards occur.
3.4.1.1 Estimating Forfeitures
ASC 718-20
Example 1: Accounting for Share Options With Service Conditions

55-4 The following Cases illustrate the guidance in paragraphs 718-10-35-1D through 35-1E for nonemployee
awards, paragraphs 718-10-35-2 through 35-7 for employee awards, and paragraphs 718-740-25-2 through
25-3 for both nonemployee and employee awards, except for the vesting provisions:
a. Share options with cliff vesting and forfeitures estimated in initial accruals of compensation cost (Case A)
b. Share options with graded vesting and forfeitures estimated in initial accruals of compensation cost (Case B)
c. Share options with cliff vesting and forfeitures recognized when they occur (Case C).
55-4A Cases A through C (see paragraphs 718-20-55-10 through 55-34G) describe employee awards. However,
the principles on accounting for employee awards, except for the compensation cost attribution, are the same
for nonemployee awards. Consequently, all of the following in Case A are equally applicable to nonemployee
awards with the same features as the awards in Cases A through C (that is, awards with a specified time period
for vesting):
a. The assumptions in paragraphs 718-20-55-6 through 55-9
b. Total compensation cost considerations (including estimates of forfeitures) in paragraphs 718-20-55-10
through 55-12
c. Changes in the estimation of forfeitures in paragraphs 718-20-55-14 through 55-15
d. Exercise or expiration considerations in paragraphs 718-20-55-18 through 55-21 and 718-20-55-23.
Therefore, the guidance in those paragraphs may serve as implementation guidance for nonemployee awards.
Similarly, an entity also may elect to account for nonemployee award forfeitures as they occur as illustrated in
Case C (see paragraph 718-20-55-34A).
55-4B Nonemployee awards may be similar to employee awards (that is, cliff vesting or graded vesting).
However, the compensation cost attribution for awards to nonemployees may be the same as or different
from employee awards. 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
54
55-5 Cases A, B, and C share all of the assumptions in paragraphs 718-20-55-6 through 55-34G, with the
following exceptions:
a. In Case C, Entity T has an accounting policy to account for forfeitures when they occur in accordance
with paragraph 718-10-35-3.
b. In Cases A and B, Entity T has an accounting policy to estimate the number of forfeitures expected to
occur, also in accordance with paragraph 718-10-35-3.
c. In Case B, the share options have graded vesting.
d. In Cases A and C, the share options have cliff vesting.
55-6 Entity T, a public entity, grants at-the-money employee share options with a contractual term of 10 years.
All share options vest at the end of three years (cliff vesting), which is an explicit service (and requisite service)
period of three years. The share options do not qualify as incentive stock options for U.S. tax purposes. The
enacted tax rate is 35 percent. In each Case, Entity T concludes that it will have sufficient future taxable income
to realize the deferred tax benefits from its share-based payment transactions.
55-7 The following table shows assumptions and information about the share options granted on January 1,
20X5 applicable to all Cases, except for expected forfeitures per year, which does not apply in Case C.
Share options granted 900,000
Employees granted options 3,000
Expected forfeitures per year 3.0%
Share price at the grant date $30
Exercise price $30
Contractual term of options 10 years
Risk-free interest rate over contractual term 1.5 to 4.3%
Expected volatility over contractual term 40 to 60%
Expected dividend yield over contractual term 1.0%
Suboptimal exercise factor 2
55-8 A suboptimal exercise factor of two means that exercise is generally expected to occur when the share
price reaches two times the share option’s exercise price. Option-pricing theory generally holds that the optimal
(or profit-maximizing) time to exercise an option is at the end of the option’s term; therefore, if an option is
exercised before the end of its term, that exercise is referred to as suboptimal. Suboptimal exercise also is
referred to as early exercise. Suboptimal or early exercise affects the expected term of an option. Early exercise
can be incorporated into option-pricing models through various means. In this Case, Entity T has sufficient
information to reasonably estimate early exercise and has incorporated it as a function of Entity T’s future stock
price changes (or the option’s intrinsic value). In this Case, the factor of 2 indicates that early exercise would be
expected to occur, on average, if the stock price reaches $60 per share ($30 × 2). Rather than use its weighted
average suboptimal exercise factor, Entity T also may use multiple factors based on a distribution of early
exercise data in relation to its stock price.
55
55-9 This Case assumes that each employee receives an equal grant of 300 options. Using as inputs the last 7
items from the table in paragraph 718-20-55-7, Entity T’s lattice-based valuation model produces a fair value
of $14.69 per option. A lattice model uses a suboptimal exercise factor to calculate the expected term (that is,
the expected term is an output) rather than the expected term being a separate input. If an entity uses a Black-
Scholes-Merton option-pricing formula, the expected term would be used as an input instead of a suboptimal
exercise factor.
Case A: Share Options With Cliff Vesting and Forfeitures Estimated in Initial Accruals of Compensation Cost
55-10 Total compensation cost recognized over the requisite service period (which is the vesting period in this
Case) shall be the grant-date fair value of all share options that actually vest (that is, all options for which the
requisite service is rendered). This Case assumes that Entity T’s accounting policy is to estimate the number
of forfeitures expected to occur in accordance with paragraph 718-10-35-3. As a result, Entity T is required
to estimate at the grant date the number of share options for which the requisite service is expected to be
rendered (which, in this Case, is the number of share options for which vesting is deemed probable). If that
estimate changes, it shall be accounted for as a change in estimate and its cumulative effect (from applying the
change retrospectively) recognized in the period of change. Entity T estimates at the grant date the number of
share options expected to vest and subsequently adjusts compensation cost for changes in the estimated rate
of forfeitures and differences between expectations and actual experience. This Case also assumes that none
of the compensation cost is capitalized as part of the cost of an asset.
55-11 The estimate of the number of forfeitures considers historical employee turnover rates and expectations
about the future. Entity T has experienced historical turnover rates of approximately 3 percent per year for
employees at the grantees’ level, and it expects that rate to continue over the requisite service period of the
awards. Therefore, at the grant date Entity T estimates the total compensation cost to be recognized over the
requisite service period based on an expected forfeiture rate of 3 percent per year. Actual forfeitures are 5
percent in 20X5, but no adjustments to cumulative compensation cost are recognized in 20X5 because Entity T
still expects actual forfeitures to average 3 percent per year over the 3-year vesting period. As of December 31,
20X6, management decides that the forfeiture rate will likely increase through 20X7 and changes its estimated
forfeiture rate for the entire award to 6 percent per year. Adjustments to cumulative compensation cost to
reflect the higher forfeiture rate are made at the end of 20X6. At the end of 20X7 when the award becomes
vested, actual forfeitures have averaged 6 percent per year, and no further adjustment is necessary.
55-12 The first set of calculations illustrates the accounting for the award of share options on January 1, 20X5,
assuming that the share options granted vest at the end of three years. (Case B illustrates the accounting for
an award assuming graded vesting in which a specified portion of the share options granted vest at the end of
each year.) The number of share options expected to vest is estimated at the grant date to be 821,406 (900,000
× .973). Thus, the compensation cost to be recognized over the requisite service period at January 1, 20X5, is
$12,066,454 (821,406 × $14.69), and the compensation cost to be recognized during each year of the 3-year
vesting period is $4,022,151 ($12,066,454 ÷ 3). The journal entries to recognize compensation cost and related
deferred tax benefit at the enacted tax rate of 35 percent are as follows for 20X5.
Compensation cost $4,022,151

Additional paid-in capital $4,022,151
Deferred tax asset $1,407,753

Deferred tax benefit $1,407,753
related to compensation cost ($4,022,151 × .35 = $1,407,753).
55-13 The net after-tax effect on income of recognizing compensation cost for 20X5 is $2,614,398 ($4,022,151
– $1,407,753).
56
55-14 Absent a change in estimated forfeitures, the same journal entries would be made to recognize
compensation cost and related tax effects for 20X6 and 20X7, resulting in a net after-tax cost for each year
of $2,614,398. However, at the end of 20X6, management changes its estimated employee forfeiture rate
from 3 percent to 6 percent per year. The revised number of share options expected to vest is 747,526
(900,000 × .943). Accordingly, the revised cumulative compensation cost to be recognized by the end of 20X7 is
$10,981,157 (747,526 × $14.69). The cumulative adjustment to reflect the effect of adjusting the forfeiture rate
is the difference between two-thirds of the revised cost of the award and the cost already recognized for 20X5
and 20X6. The related journal entries and the computations follow.
At December 31, 20X6, to adjust for new forfeiture rate.
Revised total compensation cost $ 10,981,157
Revised cumulative cost as of December 31, 20X6 ($10,981,157 × 2/3) $ 7,320,771
Cost already recognized in 20X5 and 20X6 ($4, 022,151 × 2) 8,044,302

Adjustment to cost at December 31, 20X6 $ (723,531)
55-15 The related journal entries are as follows.

To adjust previously recognized compensation cost and equity to
reflect a higher estimated forfeiture rate.

To adjust the deferred tax accounts to reflect the tax effect
of increasing the estimated forfeiture rate ($723,531 × .35 =
$253,236).
55-16 Journal entries for 20X7 are as follows.

To recognize compensation cost ($10,981,157 ÷ 3 = $3,660,386).

To recognize the deferred tax asset for additional compensation
cost ($3,660,386 × .35 = $1,281,135).
57
55-17 As of December 31, 20X7, the entity would examine its actual forfeitures and make any necessary
adjustments to reflect cumulative compensation cost for the number of shares that actually vested.
Share Option — Cliff Vesting
Cumulative
Year Total Value of Award Pretax Cost of Year Pretax Cost
20X5 $12,066,454 (821,406 × $14,69) $4,022,151 ($12,066,454 ÷ 3) $ 4,022,151
20X6 $10,981,157 (747,526 × $14.69) $3,298,620 [($10,981,157 × 2/3) – $4,022,151] $ 7,320,771
20X7 $10,981,157 (747,526 × $14.69) $3,660,386 ($10,981,157 ÷ 3) $ 10,981,157
55-18 All 747,526 vested share options are exercised on the last day of 20Y2. Entity T has already recognized its
income tax expense for the year without regard to the effects of the exercise of the employee share options. In
other words, current tax expense and current taxes payable were recognized based on income and deductions
before consideration of additional deductions from exercise of the employee share options. Upon exercise,
the amount credited to common stock (or other appropriate equity accounts) is the sum of the cash proceeds
received and the amounts previously credited to additional paid-in capital in the periods the services were
received (20X5 through 20X7). In this Case, Entity T has no-par common stock and at exercise, the share price is
assumed to be $60.
55-19 At exercise the journal entries are as follows.
Cash (747,526 × $30) $22,425,780

Common stock $33,406,937
To recognize the issuance of common stock upon exercise of share
options and to reclassify previously recorded paid-in capital.
55-20 In this Case, the difference between the market price of the shares and the exercise price on the date
of exercise is deductible for tax purposes pursuant to U.S. tax law in effect in 2004 (the share options do
not qualify as incentive stock options). Paragraph 718-740-35-2 requires that the tax effect be recognized
as income tax expense or benefit in the income statement for the difference between the deduction for an
award for tax purposes and the cumulative compensation cost of that award recognized for financial reporting
purposes. With the share price of $60 at exercise, the deductible amount is $22,425,780 [747,526 × ($60 –
$30)], and the tax benefit is $7,849,023 ($22,425,780 × .35).
55-21 At exercise the journal entries are as follows.
Deferred tax expense $3,843,406

To write off the deferred tax asset related to deductible share
options at exercise ($10,981,157 × .35 = $3,843,405).
Current taxes payable $7,849,023
Current tax expense $7,849,023

To adjust current tax expense and current taxes payable to
recognize the current tax benefit from deductible compensation
cost upon exercise of share options.
58
55-22 Paragraph superseded by Accounting Standards Update No. 2016-09.
55-23 If instead the share options expired unexercised, previously recognized compensation cost would not
be reversed. There would be no deduction on the tax return and, therefore, the entire deferred tax asset of
$3,843,405 would be charged to income tax expense.
55-23A If employees terminated with out-of-the-money vested share options, the deferred tax asset related to
those share options would be written off when those options expire.
If an entity chooses an accounting policy to estimate forfeiture rates when awards are granted, it can
base its estimate of the number of share-based payment awards that eventually will vest on a number
of different sources of information and data. For example, for employee awards, the entity may base its
estimate on the following (among other sources):
• Historical rates of forfeiture (before vesting) for awards with similar terms.
• Historical rates of employee turnover (before vesting).
• The intrinsic value of the award on the grant date.
• The volatility of the entity’s share price.
• The length of the vesting period.
• The number and value of awards granted to individual employees.
• The nature and terms of the vesting condition(s) of the award.
• The characteristics of the employee (e.g., whether the employee is a member of executive
management of the entity).
• A large population of relatively homogenous employee grants.

• Other relevant terms and conditions of the award that may affect forfeiture behavior (before
vesting).
Different groups of grantees of the same award issuance may have forfeiture rate assumptions
that differ on the basis of the facts and circumstances. In addition, many of these same sources of
information and data could be relevant for nonemployee awards. For more information, see Section
9.3.2.1.
In accordance with paragraph B166 of FASB Statement 123(R), entities that do not have sufficient
information may base forfeiture estimates on the experience of other entities in the same industry until
entity-specific information is available.
Estimated forfeiture rates should be reassessed throughout the grantee’s requisite service period (or
nonemployee’s vesting period), and changes in estimates should be reflected by using a cumulative-
effect adjustment. See Section 3.8 for more information about changes in estimates.
59
Example 3-7A
Entity A grants 1,000 at-the-money employee stock options, each with a grant-date fair-value-based measure
of $10. The options vest at the end of the fourth year of service (cliff vesting). Entity A’s accounting policy is to
estimate the number of forfeitures expected to occur in accordance with ASC 718-10-35-3. As of the grant
date, A estimates that 100 of the stock options will be forfeited during the service (vesting) period. However,
150 options are forfeited in year 3. There are no other forfeitures during the service (vesting) period. The table
below illustrates the compensation cost that is recognized on the basis of the initial estimate of forfeitures and
revised when information becomes available suggesting that actual forfeitures will differ.
Year Compensation Cost Comments
Year 1 $ 2,250 Because A estimates that 100 options will be forfeited during the
vesting period, it recognizes compensation cost for only 900 of the
1,000 options granted. Compensation cost is based on the number
of options expected to vest, the grant-date fair-value-based
measure of the options, and the amount of services rendered,
or 900 options × $10 fair-value-based measure × 25%* services
rendered.
Year 2 $ 2,250 Because there is no change in forfeiture estimate, the amount

of compensation cost is exactly the same as it was in year 1.
Compensation cost is based on the number of options expected
to vest, the grant-date fair-value-based measure of the options,
and the amount of services rendered, less amounts previously
recognized, or 900 options × $10 fair-value-based measure × 50%
services rendered – $2,250.
Year 3 $ 1,875 In year 3, 150 options are forfeited and A expects that no other
forfeitures will occur. Compensation cost is based on the number
of options expected to vest, the grant-date fair-value-based
measure of the options, and the amount of services rendered, less
amounts previously recognized, or 850 options × $10 fair-value
based measure × 75% services rendered – $4,500.
Year 4 $ 2,125 By the end of year 4, 850 options are fully vested. Compensation
cost is based on the number of options vested, the grant-date fair-
value-based measure of the options, and the amount of services
rendered, less amounts previously recognized, or 850 options ×
$10 fair-value-based measure × 100% services rendered – $6,375.
Total $ 8,500
* Percentage of employee service provided in each of the four years of required service.
60
3.4.1.2 Accounting for Forfeitures When They Occur

The example below is based on the same facts as in Case A of Example 1 in ASC 718-20-55-4 through
55-9 (see Section 3.4.1.1).
ASC 718-20
Case C: Share Options With Cliff Vesting and Forfeitures Recognized When They Occur
55-34A This Case uses the same assumptions as Case A except that Entity T’s accounting policy is to account
for forfeitures when they occur in accordance with paragraph 718-10-35-3. Consequently, compensation
cost previously recognized for an employee share option is reversed in the period in which forfeiture of the
award occurs. Previously recognized compensation cost is not reversed if an employee share option for
which the requisite service has been rendered expires unexercised. This Case also assumes that none of the
compensation cost is capitalized as part of the cost of an asset.
55-34B In 20X5, 20X6, and 20X7, share option forfeitures are 45,000, 47,344, and 60,130, respectively.
55-34C The compensation cost to be recognized over the requisite service period at January 1, 20X5, is
$13,221,000 (900,000 × $14.69), and the compensation cost to be recognized (excluding the effect of forfeitures)
during each year of the 3-year vesting period is $4,407,000 ($13,221,000 ÷ 3). The journal entries for 20X5 to
recognize compensation cost and related deferred tax benefit at the enacted tax rate of 35 percent are as follows.

To recognize compensation cost excluding the effect of forfeitures
for 20X5.

related to compensation cost ($4,407,000 × .35).
55-34D During 20X5, 45,000 share options are forfeited; accordingly, Entity T remeasures compensation
cost to reflect the effect of forfeitures when they occur and recognizes compensation costs for 855,000
(900,000 – 45,000) share options (net of forfeitures) at an amount of $12,559,950 (855,000 × $14.69) over
the 3-year vesting period, or $4,186,650 each year ($12,559,950 ÷ 3). Therefore, Entity T reverses recognized
compensation cost of $220,350 (45,000 share options × $14.69 ÷ 3) to account for forfeitures that occurred
during 20X5. The journal entries to recognize the effect of forfeitures during 20X5 and the related reduction in
the deferred tax benefit are as follows.

To recognize the effect of forfeitures on compensation cost when
they occur for 20X5.

To reverse the deferred tax asset related to the forfeited awards
($220,350 × .35).
61
55-34E As of January 1, 20X6, Entity T determines the compensation cost and related tax effects to recognize
during 20X6. The journal entries for 20X6 to recognize compensation cost and related deferred tax benefit at
the enacted tax rate of 35 percent are as follows (excluding the effect of forfeitures in 20X6).

To recognize compensation cost excluding the effect of awards that
forfeited during 20X6.

related to compensation cost ($4,186,650 × .35).
55-34F In 20X6, 47,344 share options are forfeited (that is, 92,344 share options in total have been forfeited
by December 31, 20X6); accordingly, Entity T would recognize compensation cost for 807,656 share options
over the 3-year vesting period. On the basis of actual forfeitures in 20X5 and 20X6, Entity T should recognize a
cumulative compensation cost of $11,864,467 (807,656 × $14.69) for the 3-year vesting period, or $3,954,822
a year ($11,864,467 ÷ 3 years). Therefore, Entity T reverses recognized compensation cost of $231,828
($4,186,650 – $3,954,822) for 20X5 and 20X6, or $463,656 in total, to account for forfeitures that occurred
during 20X6. The journal entries to recognize the effect of forfeitures during 20X6 and the related reduction in
the deferred tax benefit are as follows.
Additional paid-capital $463,656

To recognize the effect of the forfeitures on compensation cost
when they occur for 20X6.

To reverse the deferred tax asset related to the forfeited awards
($463,656 × .35).
55-34G Entity T follows the same approach in 20X7 as it applied in 20X6 to recognize compensation cost and
related tax effects.
The vesting of an award upon the satisfaction of a service condition may become improbable as a result
of a planned future termination of employment or a nonemployee arrangement to provide goods or
services (e.g., a plant shutdown or executive separation agreement). If an entity elects to account for
forfeitures as they occur, the accounting for planned future terminations depends on whether the
award is modified and, if so, when the modification occurs (i.e., whether the award is modified before or
on the date of termination). See Section 6.3.3.2 for further discussion of a modification in connection
with a termination. If the award is not modified, compensation cost is not reversed (i.e., the forfeiture is
not recognized) until the termination date.
62
3.4.2 Performance Condition
Performance Condition
the fair value of an award that relates to both of the following:
a. Rendering service or delivering goods for a specified (either explicitly or implicitly) period of time
b. Achieving a specified performance target that is defined solely by reference to the grantor’s own
operations (or activities) or by reference to the grantee’s performance related to the grantor’s own
operations (or activities).
Attaining a specified growth rate in return on assets, obtaining regulatory approval to market a specified
product, selling shares in an initial public offering or other financing event, and a change in control are
examples of performance conditions. A performance target also may be defined by reference to the same
performance measure of another entity or group of entities. For example, attaining a growth rate in earnings
per share (EPS) that exceeds the average growth rate in EPS of other entities in the same industry is a
performance condition. A performance target might pertain to the performance of the entity as a whole or
to some part of the entity, such as a division, or to the performance of the grantee if such performance is in
accordance with the terms of the award and solely relates to the grantor’s own operations (or activities).
Probable
The future event or events are likely to occur.
ASC 718-10
Market, Performance, and Service Conditions

25-20 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.
To satisfy an award’s performance condition, the grantee must (1) provide goods or services for a
specified period and (2) have the ability to earn the award on the basis of the operations or activities of
the grantor or the performance of the grantee related to the grantor’s own operations or activities. The
grantor’s operations or activities could include the attainment of specified financial performance targets
(e.g., revenue, EPS), operating metrics (e.g., number of items produced), or other specific actions (e.g.,
IPO, receipt of regulatory approval). The grantee’s activities could include sales generated or other goals.
Rendering service or delivering goods for a specified period can be either explicitly stated or implied
(e.g., the time it will take for the performance condition to be met).
63
If (1) the grantee does not provide the necessary goods or services for the specified period or (2) the
entity or the grantee does not attain the specified performance target, the grantee has not earned (i.e.,
vested in) the award. If the grantee does not earn the award, the entity would reverse any compensation
cost accrued during the requisite service period or nonemployee’s vesting period. Ultimately,
compensation cost is not recognized for awards that do not vest. During the service or vesting period,
the entity must assess the probability that the performance condition will be met (i.e., the probability
that the grantee will earn the award) and adjust the cumulative compensation cost recognized
accordingly. If it is not probable that the performance condition will be met, the entity should not record
any compensation cost. See Section 3.8 for more information about changes in estimates.
Since the performance condition affects the grantee’s ability to earn (i.e., vest in) the award, it is not
directly factored into the fair-value-based measure of the award. However, a performance condition can
indirectly affect the fair-value-based measure by affecting the expected term of an award that is a stock
option. Because the award’s expected term cannot be shorter than the vesting period, a longer vesting
period would result in an increase in the award’s expected term. See the discussions in Sections 4.1.1
and 4.6 on how a performance condition affects the valuation of share-based payment awards.
Although ASC 718-20-55-40 suggests that compensation cost could be recognized on the basis of
“the relative satisfaction of the performance condition,” the FASB staff believes that it would be rare to
recognize compensation cost for an employee award with only a performance condition in a manner
other than ratably over the requisite service period.
Example 3-8
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options. The options vest only if
cumulative net income over the next three annual reporting periods exceeds $1 million and the employee is
still in the employment of A.
The service period is explicitly stated in the terms of the options. The employee must provide three years of
continuous service to A to earn the options. In addition, A must meet the specified performance target of
cumulative net income in excess of $1 million over the next three annual reporting periods. If either (1) the
employee does not remain in the employment of A for the specified period or (2) A does not attain the
performance target, the options will be forfeited and any compensation cost previously recognized by A will be
reversed. Compensation cost will be recognized on a straight-line basis (i.e., one-third for each year of service)
over the three-year service period if it is probable that the performance condition will be met.
3.4.2.1 Performance Conditions Associated With Liquidity Events

A liquidity event (e.g., IPO or change in control) represents a performance condition under ASC 718 if
the grantee’s ability to earn the award is contingent on the grantee’s rendering of service or delivery of
goods and the entity’s attainment of the specified performance target (i.e., the liquidity event). Because
a performance condition affects the grantee’s ability to earn the award, it is not directly factored into the
award’s fair-value-based measure.
During the service or vesting period, the entity must assess the probability that the performance
condition (e.g., liquidity event) will be met (i.e., the probability that the grantee will earn the award). A
liquidity event such as a change in control or an IPO is generally not considered probable until it occurs.
This position is consistent with the guidance in ASC 805-20-55-50 and 55-51 on liabilities that are
triggered upon the consummation of a business combination. Accordingly, an entity generally does not
recognize compensation cost related to awards that vest upon a change in control or an IPO until the
event occurs.
64
One exception to the probability assessment is a performance condition that is related to a change-in-
control event associated with an entity’s sale of its business unit (or subsidiary) to a third party. Such a
sale may be considered probable before the change-in-control event occurs if the sale meets the held-
for-sale criteria in ASC 360. If those criteria are satisfied, there is a presumption that the sale is probable.
Therefore, a performance condition that is based on the sale of a business unit may be satisfied before
the actual sale occurs if the business unit meets the held-for-sale criteria in ASC 360.
3.4.2.2 Performance Conditions Satisfied After the Requisite Service Period or the

Nonemployee’s Vesting Period
ASC 718-10
30-28 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.
ASC 718-10-30-28 specifies that a shared-based payment award with established performance targets
that affect vesting and that could be achieved after a grantee completes the requisite service or a
nonemployee’s vesting period (i.e., the grantee would be eligible to vest in the award regardless of
whether the grantee is delivering goods or rendering service on the date the performance target could
be achieved) should be treated as a performance condition that is a vesting condition. Therefore,
these performance targets should not be directly reflected in the award’s fair-value-based measure.
For example, the terms of an award to an employee may allow the award to vest upon completion
of an IPO (i.e., the performance target) even if the IPO occurs after the employee has completed the
requisite service period. This may be the case for employee awards that permit continued vesting upon
retirement; that is, an employee who is retirement-eligible (or who becomes retirement-eligible) can
retain the award upon retirement and vest in the award if the performance target is achieved even if the
target is achieved after the employee retires. See Section 3.6.6.1 for a discussion of the accounting for
awards granted to retirement-eligible employees that vest only upon service conditions.
When a performance-based award is granted to a retirement-eligible employee or otherwise permits

vesting after termination of employment, the performance condition will not be factored into the
determination of the requisite service period if the period associated with the performance target falls
65
after the retirement eligibility date or after the requisite service period. Instead, the requisite service
period will be determined solely on the basis of the service condition.
In accordance with ASC 718-10-55-87 and 55-88, for awards that permit continued vesting upon
retirement, the requisite service period will either be (1) immediate (for retirement-eligible employees)
or (2) the shorter of (a) the time from the grant date until the employee becomes retirement-eligible or
(b) any service period associated with the performance target. Because the performance target of the
award is viewed as a performance condition, an entity must assess the probability that the performance
condition will be met. If achievement of the performance target is not probable, an entity should not
record any compensation cost.
If an entity recorded compensation cost (because achievement of the performance target was
deemed probable) and the performance target is not achieved, the entity would reverse any previously
recognized compensation cost, even if the holder of the award is no longer providing goods or services
(e.g., an employee had retired). Conversely, if the entity did not record compensation cost (because
achievement of the performance target was not deemed probable) and the performance condition
is met (or meeting it became probable), the entity would record compensation cost on the date the
performance condition is met (or meeting it became probable), even if the holder of the award is no
longer providing goods or services.
Example 3-9
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options, each with a grant-date fair-
value-based measure of $9, to employees who are currently retirement-eligible. The options legally vest and
become exercisable only if cumulative net income over the next three annual reporting periods exceeds $1
million. The employees can retain the options for the remaining contractual life of the options even if they elect
to retire. However, the options only become exercisable upon the achievement of the cumulative net income
target.
In this example, the three-year service period is nonsubstantive. That is, even though the performance
condition implies a service period of three years, the employees could retire the next day and retain the
options. However, for the options to legally vest and become exercisable the entity must meet the specified
performance target of cumulative net income in excess of $1 million over the next three annual reporting
periods. Therefore, A records the $9,000 ($9 grant-date fair-value-based measure × 1,000 options) of
compensation cost immediately on the grant date if it is probable that the performance target will be met (i.e.,
it is probable the entity will achieve net income of $1 million over the next three annual reporting periods). If it
becomes improbable that the performance target will be met or A does not achieve the performance target,
the options will be forfeited and any compensation cost previously recognized by A will be reversed even if the
employees are no longer employed (i.e., they retired).
3.4.3 Repurchase Features That Function as Vesting Conditions

Repurchase features included in a share-based payment award may at times function in substance as
vesting conditions. ASC 718-10-25-9 and 25-10 discuss the appropriate classification (i.e., liability versus
equity) of awards with certain share-associated repurchase features. Specifically, these paragraphs
discuss awards that contain (1) a grantee’s right to require the entity to repurchase the share (a put
option) or (2) an entity’s right to repurchase the share from the grantee (a call option). However, when a
restricted stock award includes a repurchase feature associated with an entity’s right to repurchase the
underlying shares at either (1) cost (which often is zero) or (2) the lesser of the fair value of the shares
on the repurchase date or the cost of the award, the restricted stock award should not be assessed
under the provisions of ASC 718-10-25-9 and 25-10. Likewise, when a stock option or similar instrument
is capable of being “early exercised” and includes a similar repurchase feature associated with an
66
entity’s right to repurchase the underlying shares, the stock option or similar instrument should not be
assessed under the provisions of ASC 718-10-25-9 and 25-10. See Section 5.3 for a discussion of share
repurchase features that should be assessed under the guidance in ASC 718-10-25-9 and 25-10.
An early exercise refers to a grantee’s ability to change his or her tax position by exercising an option
or similar instrument and receiving shares before the award is vested. The early exercise of an award
results in the grantee’s deemed ownership of the shares for U.S. federal income tax purposes, which in
turn results in the commencement of the share’s holding period (under the tax law). Once the shares
are held by the grantee for the required holding period, any gain realized upon the sale of those shares
is taxed at a capital gains tax rate rather than an ordinary income tax rate.
Because the awards are exercised before they vest, if the grantee ceases to provide goods or services
before the end of this period, the entity issuing the shares usually can repurchase the shares for either
of the following:
• The lesser of the fair value of the shares on the repurchase date or the exercise price of the
award.
• The exercise price of the award.

The purpose of the repurchase feature (whether for restricted stock or stock options) is effectively to
require that before receiving any economic benefit from the award, the grantee must continue providing
goods or services until the award vests. For stock options, the early exercise is therefore not considered
to be a substantive exercise for accounting purposes; any payment received by the entity for the
exercise price should be recognized as a deposit liability. The fact that the grantee was able to exercise
the award early does not indicate that the vesting condition was satisfied, since the repurchase feature
prevents the grantee from receiving any economic benefit from the award until the entity’s repurchase
feature expires upon the award’s vesting. ASC 718-10-55-31(a) confirms this conclusion, stating, in part:
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.
In effect, the repurchase feature functions as a forfeiture provision rather than a cash settlement
feature. That is, if the grantee continues to provide the goods or services until the award vests, the
restriction (the repurchase feature) will lapse. By contrast, if the grantee ceases providing the goods or
services before the awards vest, the entity will repurchase the shares (in effect, as though the shares
were never issued).
An entity’s election not to repurchase an issued share if a grantee ceases to provide goods or services
before the award vests is accounted for as a modification that, in effect, accelerates the vesting of the
award. The modification is accounted for as a Type III improbable-to-probable modification. That is, on
the date on which the grantee ceases to provide goods or services, the original award is not expected
to vest. Accordingly, no compensation cost is recognized for the original award, and any previously
recognized compensation cost is reversed. On the date the entity decides not to repurchase the
shares (which generally is contemporaneous with the employee’s termination or the date on which a
nonemployee ceases to provide goods or services), the entity would determine the fair-value-based
measure of the modified award (i.e., the award that is fully vested). The fair-value-based measure of
the modified award is recorded immediately, since the award’s vesting is effectively accelerated upon
termination. See Section 6.3 for a discussion of the accounting for a modification of share-based
payment awards with performance and service vesting conditions, and see Section 6.3.3 for examples
illustrating improbable-to-probable modifications.
67
Example 3-10
Entity A grants 1,000 stock awards to an employee that are fully vested upon grant. However, if the employee
voluntarily terminates employment within two years, A has the right to call the shares at the lower of cost or fair
value.
Since the repurchase feature (i.e., the call option) functions as an in-substance service condition, the term that
states that the awards are fully vested is not substantive. If the employee leaves within two years, the shares
would be forfeited because A could exercise its call option. Accordingly, the requisite service period is two
years.
3.5 Market Condition
Market Condition
A condition affecting the exercise price, exercisability, or other pertinent factors used in determining the fair
value of an award under a share-based payment arrangement that relates to the achievement of either of the
following:
a. A specified price of the issuer’s shares or a specified amount of intrinsic value indexed solely to the
issuer’s shares
b. A specified price of the issuer’s shares in terms of a similar (or index of similar) equity security
(securities). The term similar as used in this definition refers to an equity security of another entity
that has the same type of residual rights. For example, common stock of one entity generally would be
similar to the common stock of another entity for this purpose.
ASC 718-10
Market Conditions
30-14 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.

30-27 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.
General
35-4 An entity shall reverse previously recognized compensation cost for an award with a market condition only
if the requisite service is not rendered.
Implementation Guidance
68
55-61 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 718-20-55-4 through 55-50)
provide illustrations of awards in which vesting is based solely on performance or service conditions.
55-62 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.
Unlike a service or performance condition, a market condition is not a vesting condition but is directly
factored into the fair-value-based measure of an award. See Section 4.5 for a discussion of how a
market condition affects the valuation of a share-based payment award. Examples of market conditions
include:
• The achievement of a specified price of an entity’s stock.

• A specified return on an entity’s stock (often referred to as total shareholder return, or TSR) that
exceeds the average return of a peer group of entities or a specified index (such as the S&P
500).
• A percentage increase in an entity’s stock price that is greater than the average percentage
increase of the stock price of a peer group of entities or a specified index.
• A specified return on an entity’s stock based on invested capital (such as a realized internal rate
of return or multiples of invested capital for private-equity investors).
Certain awards contain only a market condition. That is, they do not specify a service or vesting
period but require the grantee to provide goods or services until the market condition is met. When
an employee award contains only a market condition, the entity must use a derived service period
to determine whether the employee has provided the requisite service to earn the award. While
determining the derived service period applies to employee awards only, for certain nonemployee
awards, an entity may analogize to the guidance on calculating a derived service period when
determining whether it should recognize compensation cost. See Section 3.6.3 for a discussion of an
employee’s derived service period.
69
If an employee does not remain employed for the derived service period (i.e., the employee forfeits the
award during the derived service period), the employee has not earned (i.e., vested in) the award. An
entity accrues compensation cost over the derived service period if the requisite service is rendered;
however, the entity will reverse any previously recognized compensation cost if the employee leaves
before the completion of the derived service period. This is true unless the market condition affects the
employee’s ability to exercise or retain the award and the market condition is satisfied before the end
of the derived service period (i.e., the market condition is satisfied sooner than originally anticipated
and the employee is still employed as of the actual date of satisfaction). In that case, any unrecognized
compensation cost is recognized immediately when the market condition is satisfied. However, if an
entity instead determines that the market condition is expected to be satisfied later than originally
anticipated, the entity would not revise its estimate of the requisite service period.
Conversely, if an employee does remain employed for the derived service period, the employee has
earned (i.e., vested in) the award. In this circumstance, recognition of compensation cost will depend
on whether the award is classified as equity or liability. For an equity-classified award, an entity will not
reverse any previously recognized compensation cost even if the market condition is never satisfied.
For a liability-classified award (see Section 7.2.2), although the effect of a market condition is reflected
in the award’s fair-value-based measure, its remeasurement is performed at the end of each reporting
period until settlement. Therefore, even if the goods and services are rendered for a liability-classified
award, the final compensation cost will be zero if the award is not earned because a market condition
was not satisfied (i.e., its fair-value-based measure would be zero upon the date of settlement). In
addition, cumulative compensation cost recognized for a liability-classified award that was modified from
an equity-classified award cannot be less than the grant-date fair value of the original equity-classified
award unless, as of the modification date, vesting of the original award was not probable. See Section
6.8.1 for more information.
3.6 Requisite Service Period for Employee Awards

Determining the requisite service period is only applicable to employee awards. However, for certain
nonemployee awards, an entity may analogize to the guidance on calculating a requisite service period
and determining the service inception date when relevant to determining the nonemployee’s vesting
period. For additional discussion of a nonemployee’s vesting period, see Section 9.3.2.
Requisite Service Period

The period or periods during which an employee is required to provide service in exchange for an award under
a share-based payment arrangement. The service that an employee is required to render during that period is
referred to as the requisite service. 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. If an award requires future
service for vesting, the entity cannot define a prior period as the requisite service period. Requisite service
periods may be explicit, implicit, or derived, depending on the terms of the share-based payment award.
70
ASC 718-10
25-21 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 718-10-55-60 through 55-63 provide guidance on applying this provision to awards with market,
performance, or service conditions (or any combination thereof).
Requisite Service Period

30-25 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.
30-26 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.
Recognition of Employee Compensation Costs Over the Requisite Service Period

35-2 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.
Estimating the Requisite Service Period for Employee Awards

35-5 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 718-10-55-69
through 55-79 and 718-10-55-93 through 55-106 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.
71
55-61A An employee award containing one or more market conditions may have an explicit, implicit, or derived
service period. Paragraphs 718-10-55-69 through 55-79 provide guidance on explicit, implicit, and derived
service periods.
Estimating the Employee’s Requisite Service Period

55-67 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.
55-68 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.
72
3.6.1 Explicit Service Period for Employee Awards

Explicit Service Period

A service period that is explicitly stated in the terms of a share-based payment award. For example, an award
stating that it vests after three years of continuous employee service from a given date (usually the grant date)
has an explicit service period of three years. . . .
ASC 718-10
Explicit, Implicit, and Derived Employee’s Requisite Service Periods

55-69 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 explicit service period is the period stated in the terms of a share-based payment award during
which the employee is required to provide continuous service to earn the award. For example, an award
stating that it vests after two years of continuous service has an explicit service period of two years.
3.6.2 Implicit Service Period for Employee Awards

Implicit Service Period

A service period that is not explicitly stated in the terms of a share-based payment award but that may be
inferred from an analysis of those terms and other facts and circumstances. For instance, if an award of share
options vests upon the completion of a new product design and it is probable that the design will be completed
in 18 months, the implicit service period is 18 months. . . .
ASC 718-10
55-70 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.
An award may have a performance condition (see Section 3.4.2) that specifies an explicit service period,
an implicit service period, or both. If the award vests upon the satisfaction of a performance target over
a two-year period and the employee is required to be employed during that period, the service period
is explicit. If, instead, the award vests when a performance target is met and the employee is required
to be employed until such time, the service period is implicit. The period during which the performance
condition is expected to be met is the implicit service period.
73
3.6.3 Derived Service Period for Employee Awards

Derived Service Period

A service period for an award with a market condition that 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 the employee can exercise only if the share price increases by 25 percent at any time during a 5-year
period can be inferred from certain valuation techniques. 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 satisfaction (as inferred from the valuation technique). If the derived service period is three
years, the estimated requisite service period is three years and all compensation cost would be recognized
over that period, unless the market condition was satisfied at an earlier date. Compensation cost would not be
recognized beyond three years even if after the grant date the entity determines that it is not probable that the
market condition will be satisfied within that period. Further, an award of fully vested, deep out-of-the-money
share options has a derived service period that must be determined from the valuation techniques used to
estimate fair value. . . .
ASC 718-10
55-71 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.
A derived service period is unique to share-based payment awards that contain a market condition.
As described in ASC 718-10-55-71 and defined in ASC 718-10-20, a derived service period is the “time
from the service inception date to the expected date of satisfaction” of the market condition. Entities
can infer this period by using a valuation technique (such as a lattice-based model) to estimate the fair-
value-based measure of an award with a market condition. For example, an award may have a condition
making the award exercisable only when the share price increases by 25 percent. In a lattice-based
model, there will be a number of possible paths that reflect an increase in share price by 25 percent.
Entities infer the derived service period by using the median share price path or, in other words, the
midpoint period over which the share price is expected to increase by 25 percent.
74
When an award only has a market condition without an explicit service period (i.e., it requires the
employee to remain employed until the market condition is met), the derived service period is the
requisite service period. That is, the derived service period establishes the period over which an entity
recognizes the compensation cost for a share-based payment award with only a market condition. If
the market condition is satisfied on an earlier date, any unrecognized compensation cost is recognized
immediately on the date of satisfaction of the market condition. See Section 3.7 for a more detailed
discussion of the requisite service period of awards with multiple conditions.
In addition, see Section 3.5 for a discussion of the accounting for awards with only a market condition.
3.6.4 Service Inception Date

Service Inception Date

The date at which the employee’s requisite service period or the nonemployee’s vesting period begins. The
service inception date usually is the grant date, but the service inception date may differ from the grant date
(see Example 6 [see paragraph 718-10-55-107] for an illustration of the application of this term to an employee
award).
ASC 718-10
35-6 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.
Example 6: Service Inception Date and Grant Date for Employee Awards
55-107 The following Example illustrates the guidance in paragraph 718-10-35-6.
55-108 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).
55-109 In certain circumstances the service inception date may begin after the grant date (see paragraphs
718-10-55-93 through 55-94 for an example illustrating that circumstance).
75
55-110 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).
55-111 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.
55-112 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).
55-113 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.
55-114 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.
76
55-115 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.
ASC 718 distinguishes between service inception date and grant date. The service inception date is the
date on which the employee’s requisite service period or the nonemployee’s vesting period begins and
is usually the grant date. However, sometimes the service inception date can precede the grant date.
For employee awards, ASC 718-10-55-108 states that if all of the following criteria are met, the service
inception date precedes the grant date:
a. An award is authorized. [See Section 3.6.4.1.]
b. Service begins before a mutual understanding of the key terms and conditions of a share-based
payment award is reached. [See Section 3.6.4.2.]
c. Either of the following conditions applies:
1. The award’s terms do not include a substantive future requisite service condition . . . at the grant
date. [See Section 3.6.4.3.]
2. The award contains a market or performance condition that if not satisfied during the service period
preceding the grant date . . . results in forfeiture of the award. [See Section 3.6.4.4.]
All three criteria in ASC 718-10-55-108(a)–(c) must be met for the service inception date to precede the
grant date; however, only one of the two conditions in ASC 718-10-55-108(c) must be satisfied.
If it is determined that the service inception date precedes the grant date, compensation cost should be
recognized as described in Section 3.6.4.5.
3.6.4.1 Award Authorization
Typically, the approvals necessary for establishing a service inception date under ASC 718-10-55-108(a)
are the same as those required for establishing a grant date (see Section 3.2.1). However, some entities
have performance-based compensation arrangements in which the terms of the plan or strategy have
received the necessary approvals but the final compensation amount that each individual employee will
receive will not be finalized by a board of directors, a compensation committee, or other governance
body until after the performance period. For example, an entity may have an annual bonus program
that is (1) settled in a combination of cash and shares and (2) based on the achievement of performance
or market metrics for a particular year, but the program may not be finalized by the compensation
committee and communicated to employees until shortly after the annual performance period.
Generally, a grant date for the amount settled in shares1 will not be established until, at the earliest, the
compensation committee finalizes the compensation amount and the number of shares allocated to
each employee after the performance period. We believe that the following two views are acceptable
1
In some cases, the portion settled in shares may not be determined up front but could be estimated on the basis of past practice, plan terms, or
communications to employees. Note that the portion settled in cash is typically accounted for under other U.S. GAAP unless it meets the scope
77
in the assessment of whether the authorization criterion has been met in an entity’s determination of
whether a service inception date has been established before the grant date:
• Narrow view — Under this view, the awards are authorized on the date on which (1) all required
approvals are obtained (including any required actions of the compensation committee or
other governance body) and (2) the key terms and conditions of the awards are finalized
(including the portion settled in shares to be issued to each employee). That is, satisfaction of
the authorization criterion related to determining the service inception date would be evaluated
in the same manner as the entity’s determination of when the grant date approval requirement
is met for each employee’s award. See Section 3.2.1 for further discussion of the approval
requirement in establishing a grant date.
• Broad view — In establishing the service inception date, an entity does not need to have finalized
the specific details of the award at the individual-employee level to conclude that the awards
have been authorized. The entity may instead consider factors that provide evidence to support
that the awards have been authorized, such as:
o Whether the board of directors, compensation committee, or other governance body has
approved an overall compensation plan or strategy that includes the awards.
o Whether the employees have a sufficient understanding of the compensation plan or
strategy, including an awareness that they are working toward certain performance metrics
or goals and have an expectation that the awards will be granted if the related performance
metrics or goals are achieved.
The following considerations may also be relevant in the determination of whether the initial
authorization is substantive and therefore the authorization criterion is met:
o Whether the compensation plan or strategy outlines how the awards will be allocated to
each employee, and how the amount (quantity or monetary amount) of each employee’s
award will be determined. A formally authorized policy or established past practices that
define or create an understanding by the board of directors or compensation committee
of the performance metrics for determining the awards allocated to each employee may
support a conclusion that the initial authorization is substantive.
o Whether the board of directors’ or compensation committee’s approval process for finalizing
the awards after the performance period has ended is substantive relative to the initial
authorization, including the nature and degree of discretion the board or committee has
and uses to deviate from the compensation plan or strategy previously approved and
understood. In certain cases, such discretion may cause the initial approval process to be
considered less substantive, calling into question whether the authorization criterion has
been met.
The evaluation and interpretation of whether proper authorization has occurred may involve
considerable judgment and should be based on all relevant facts and circumstances. An entity must
elect, as an accounting policy, to use either the narrow or broad view of authorization, and it must apply
its elected view consistently and provide appropriate disclosures.
78
3.6.4.2 Service Begins
If the recipient of an award has commenced employment before a mutual understanding of the key
terms and conditions is reached, service will have begun under ASC 718-10-55-108(b). See Section 3.2
for additional discussion of reaching a mutual understanding of key terms and conditions.
3.6.4.3 No Substantive Future Requisite Service as of the Grant Date

An award satisfies ASC 718-10-55-108(c)(1) if it has no service condition after the grant date. Even if
the award has a stated vesting period, the service condition might not be substantive (e.g., retirement-
eligible employees). See Section 3.6.6 for further discussion of nonsubstantive service conditions.
Example 3-11
On January 1, 20X1, an entity informs one of its employees that it will grant 1,000 fully vested equity-classified
stock options to the employee on January 1, 20X2, as long as the employee is still employed on that date. The
exercise price of the options will equal the market price of the entity’s shares on January 1, 20X2. All necessary
approvals for the future grant of these options are received by January 1, 20X1.
The grant date is January 1, 20X2, since the employee neither benefits from, nor is adversely affected by,
subsequent changes in the price of the entity’s shares until that date. There is no substantive requirement
for additional service to be rendered after December 31, 20X1. Accordingly, the service inception is January 1,
20X1, and compensation cost is recorded from January 1, 20X1, to December 31, 20X1.
Example 3-12
stock options to the employee on January 1, 20X3, as long as the employee is still employed on that date. The
exercise price of the options will equal the market price of the entity’s shares on January 1, 20X2. All necessary
approvals for the future grant of these options are received by January 1, 20X1.
subsequent changes in the price of the entity’s shares until that date. Because there is a requirement for the
employee to provide service from January 1, 20X2, to December 31, 20X2, the options contain a “substantive
future requisite service condition . . . at the grant date.” Further, there are no market or performance conditions
that may result in forfeiture of the options before the grant date. Accordingly, the service inception date is
January 1, 20X2 — the grant date. Compensation cost would be recognized over the period from January 1,
20X2, to December 31, 20X2.
3.6.4.4 Forfeiture Because a Market or Performance Condition Was Not Satisfied

Before the Grant Date
To determine whether the service inception date precedes the grant date, an entity that concludes that
an award has a substantive future service requirement after the grant date must evaluate whether the
award contains a market or performance condition that could result in its forfeiture before the grant
date under ASC 718-10-55-108(c)(2). In other words, the service inception date may still precede the
grant date despite the presence of a substantive future service requirement if the award contains a
market or performance condition that must be met before the grant date.
79
Example 3-13
stock options to the employee on January 1, 20X3, as long as the employee (1) is still employed on that date
and (2) sells 1,000 units of product during 20X1. The exercise price of the options will equal the market price of
the entity’s shares on January 1, 20X2. All necessary approvals for the future grant of these options are received
by January 1, 20X1.
subsequent changes in the price of the entity’s shares until that date. Because the employee could forfeit the
options by not selling enough units of product before January 1, 20X2 (the grant date), the service inception
date precedes the grant date (i.e., condition (c)(2), discussed above, is met). Accordingly, the service inception
date is January 1, 20X1, and the grant date is January 1, 20X2. Compensation cost would be recognized over the
period from January 1, 20X1, to December 31, 20X2.
In some cases, the performance or market condition associated with each employee’s award may be
specific and well-defined. In other cases, a specific and well-defined performance or market condition
may be associated with an entity’s overall plan or strategy but not with each employee’s award. In a
manner similar to its selection of a broad or narrow view regarding award authorization under ASC
718-10-55-108(a) (see Section 3.6.4.1), an entity would make an accounting policy election related to its
evaluation under ASC 718-10-55-108(c)(2) as follows:
• Narrow view — The terms of each employee’s award must include a performance or market
condition that is sufficiently specific or defined.
• Broad view — The performance or market condition associated with the overall plan or strategy
must be sufficiently specific or defined even though the amount that will be allocated to each
employee is not.
An entity may elect a different policy under ASC 718-10-55-108(a) for award authorization than it elects
under ASC 718-10-55-108(c)(2) for evaluation of a performance or market condition. That is, an entity
that has elected to apply a broad view of ASC 718-10-55-108(a) may elect to apply a narrow view of ASC
718-10-55-108(c)(2) and vice versa. However, the entity must consistently apply the approach it selects
for each condition and must make the appropriate disclosures.
Depending on an award’s substantive terms and how those terms vary among employees, an entity may
end up applying ASC 718-10-55-108(c)(1) to one group of employees and ASC 718-10-55-108(c)(2) to
another. A commonly cited example is the issuance of awards that permit retirement-eligible employees
to continue to vest after retirement. In this instance, if an entity (1) applies a broad view related to both
authorization and whether a performance or market condition exists and (2) concludes that a service
inception date precedes the grant date for both groups of employees, it could end up applying ASC
718-10-55-108(c)(1) to retirement-eligible employees while applying ASC 718-10-55-108(c)(2) to those
employees who are not retirement-eligible. However, in other circumstances, the entity’s conclusions
regarding whether a service inception date has been established before the grant date may be different
for the two sets of employees. For example, if an entity applies a broad view related to authorization
but a narrow one for determining whether a performance or market condition exists, it may end up
concluding that a service inception date precedes the grant date for retirement-eligible employees but
not for employees who are not retirement-eligible.
80
It is also common for awards to have graded vesting. If an entity applies a broad view regarding both
authorization and determining whether a performance or market condition exists, and there is a
substantive service requirement on a graded-vesting schedule, the entity may be precluded from
electing a straight-line attribution method as its accounting policy under ASC 718-10-35-8. The straight-
line attribution method is permitted for awards that only have service conditions and would therefore
not apply to awards with other conditions (e.g., a market condition or a performance condition, unless
the only performance condition is a change in control or an IPO that accelerates vesting). See Section
3.6.5 for further discussion of attribution methods for awards with graded vesting.
3.6.4.5 Recognition of Compensation Cost

If the service inception date precedes the grant date, compensation cost is remeasured on the basis
of the award’s estimated fair-value-based measure at the end of each reporting period until the grant
date, to the extent that service has been rendered in proportion to the total requisite service period.
In the period in which the grant date occurs, cumulative compensation cost is adjusted to reflect the
cumulative effect of measuring compensation cost on the basis of the fair-value-based measure of
the award on the grant date and is not subsequently remeasured (provided that the award is equity
classified).
Example 3-14
stock options to the employee on January 1, 20X3, as long as the employee (1) is still employed on that date
and (2) sells 1,000 units of product during 20X1. The exercise price of the options will equal the market price of
the entity’s shares on January 1, 20X2. All necessary approvals for the future grant of these options are received
by January 1, 20X1. Accordingly, the service inception date is January 1, 20X1, and the grant date is January 1,
20X2.
Compensation cost is recognized on the basis of the proportion of service rendered over the period from
January 1, 20X1, to December 31, 20X2 (assuming that the performance condition is probable). From the
service inception date until the grant date (January 1, 20X1, to December 31, 20X1), the entity remeasures the
options at their fair-value-based measure at the end of each reporting period on the basis of the assumptions
that exist on those dates. Once the grant date is established (January 1, 20X2), the entity discontinues
remeasuring the options at the end of each reporting period. That is, the compensation cost that is recognized
over the remaining service period (January 1, 20X2, to December 31, 20X2) is based on the fair-value-based
measure on the grant date.
3.6.5 Graded Vesting for Employee Awards

ASC 718-10
Graded Vesting Employee Awards

35-8 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). . . .
The example below is based on the same facts as in Case A of Example 1 in ASC 718-20-55-4 through
55-9 (see Section 3.4.1.1).
81
ASC 718-20
55-4C Because of the differences in compensation cost attribution, the accounting policy election illustrated in
Case B (see paragraph 718-20-55-25) does not apply to nonemployee awards.
Case B: Share Options With Graded Vesting

55-25 Paragraph 718-10-35-8 provides for the following two methods to recognize compensation cost for
awards with graded vesting:
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 (graded vesting attribution method)
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), subject to the limitation noted in
paragraph 718-10-35-8.
55-26 The choice of attribution method for awards with graded vesting schedules is a policy decision that is not
dependent on an entity’s choice of valuation technique. In addition, the choice of attribution method applies to
awards with only service conditions.
55-27 The accounting is illustrated below for both methods and uses the same assumptions as those noted in
Case A except for the vesting provisions.
55-28 Entity T awards 900,000 share options on January 1, 20X5, that vest according to a graded schedule of
25 percent for the first year of service, 25 percent for the second year, and the remaining 50 percent for the
third year. Each employee is granted 300 share options. The following table shows the calculation as of January
1, 20X5, of the number of employees and the related number of share options expected to vest. Using the
expected 3 percent annual forfeiture rate, 90 employees are expected to terminate during 20X5 without having
vested in any portion of the award, leaving 2,910 employees to vest in 25 percent of the award (75 options).
During 20X6, 87 employees are expected to terminate, leaving 2,823 to vest in the second 25 percent of the
award. During 20X7, 85 employees are expected to terminate, leaving 2,738 employees to vest in the last
50 percent of the award. That results in a total of 840,675 share options expected to vest from the award of
900,000 share options with graded vesting.
Share Option — Graded Vesting — Estimated Amounts
Year Number of Employees Number of Vested Share Options
Total at date of grant 3,000
20X5 3,000 – 90 (3,000 × .03) = 2,910 2,910 × 75 (300 × 25%) = 218,250
20X6 2,910 – 87 (2,910 × .03) = 2,823 2,823 × 75 (300 × 25%) = 211,725
20X7 2,823 – 85 (2,823 × .03) = 2,738 2,738 × 150 (300 × 50%) = 410,700
Total vested options 840,675
82
55-29 The value of the share options that vest over the three-year period is estimated by separating the total
award into three groups (or tranches) according to the year in which they vest (because the expected life
for each tranche differs). The following table shows the estimated compensation cost for the share options
expected to vest. The estimates of expected volatility, expected dividends, and risk-free interest rates are
incorporated into the lattice, and the graded vesting conditions affect only the earliest date at which suboptimal
exercise can occur (see paragraph 718-20-55-8 for information on suboptimal exercise). Thus, the fair value of
each of the 3 groups of options is based on the same lattice inputs for expected volatility, expected dividend
yield, and risk-free interest rates used to determine the value of $14.69 for the cliff-vesting share options (see
paragraphs 718-20-55-7 through 55-9). The different vesting terms affect the ability of the suboptimal exercise
to occur sooner (and affect other factors as well, such as volatility), and therefore there is a different expected
term for each tranche.
Share Option — Graded Vesting — Estimated Cost
Year Vested Options Value per Option Compensation Cost
20X5 218,250 $ 13.44 $ 2,933,280
20X6 211,725 14.17 3,000,143
20X7 410,700 14.69 6,033,183
840,675 $ 11,966,606
55-30 Compensation cost is recognized over the periods of requisite service during which each tranche of
share options is earned. Thus, the $2,933,280 cost attributable to the 218,250 share options that vest in 20X5
is recognized in 20X5. The $3,000,143 cost attributable to the 211,725 share options that vest at the end of
20X6 is recognized over the 2-year vesting period (20X5 and 20X6). The $6,033,183 cost attributable to the
410,700 share options that vest at the end of 20X7 is recognized over the 3-year vesting period (20X5, 20X6,
and 20X7).
55-31 The following table shows how the $11,966,606 expected amount of compensation cost determined at
the grant date is attributed to the years 20X5, 20X6, and 20X7.
Share Option — Graded Vesting — Computation of Estimated Cost
Pretax Cost to Be Recognized
20X5 20X6 20X7
Share options vesting in 20X5 $ 2,933,280
Share options vesting in 20X6 1,500,071 $ 1,500,072
Share options vesting in 20X7 2,011,061 2,011,061 $ 2,011,061
Cost for the year $ 6,444,412 $ 3,511,133 $ 2,011,061
Cumulative cost $ 6,444,412 $ 9,955,545 $ 11,966,606
83
55-32 Entity T could use the same computation of estimated cost, as in the preceding table, but could elect
to recognize compensation cost on a straight-line basis for all graded vesting awards. In that case, total
compensation cost to be attributed on a straight-line basis over each year in the 3-year vesting period is
approximately $3,988,868 ($11,966,606 ÷ 3). Entity T also could use a single weighted-average expected life
to value the entire award and arrive at a different amount of total compensation cost. Total compensation
cost could then be attributed on a straight-line basis over the three-year vesting period. However, this Topic
requires that compensation cost recognized at any date must be at least equal to the amount attributable to
options that are vested at that date. For example, if 50 percent of this same option award vested in the first
year of the 3-year vesting period, 436,500 options [2,910 × 150 (300 × 50%)] would be vested at the end of
20X5. Compensation cost amounting to $5,866,560 (436,500 × $13.44) attributable to the vested awards would
be recognized in the first year.
55-33 Compensation cost is adjusted for awards with graded vesting to reflect differences between estimated
and actual forfeitures as illustrated for the cliff-vesting options, regardless of which method is used to estimate
value and attribute cost.
55-34 Accounting for the tax effects of awards with graded vesting follows the same pattern illustrated in
paragraphs 718-20-55-20 through 55-23. However, unless Entity T identifies and tracks the specific tranche
from which share options are exercised, it would not know the recognized compensation cost that corresponds
to exercised share options for purposes of calculating the tax effects resulting from that exercise. If an entity
does not know the specific tranche from which share options are exercised, it should assume that options are
exercised on a first-vested, first-exercised basis (which works in the same manner as the first-in, first-out [FIFO]
basis for inventory costing).
Some share-based payment awards may have a graded vesting schedule (i.e., awards that are split into
multiple tranches in which each tranche legally vests separately) instead of cliff vesting (i.e., all awards
vest at the end of the vesting period). For example, an entity may grant an employee 1,000 awards in
which 250 of the awards legally vest for each of four years of service provided. Under ASC 718-10-35-8,
an entity may recognize compensation cost for an award with only a service condition that has a graded
vesting schedule on either (1) an accelerated basis as though each separately vesting portion of the
award was, in substance, a separate award or (2) a straight-line basis over the total requisite service
period for the entire award.
As a result of an entity’s use of certain valuation techniques to determine the fair-value-based measure
of a share-based payment award of stock options with only a service condition that has a graded vesting
schedule, each portion of the award that vests separately may directly or indirectly be valued as an
individual award. That is, directly or indirectly, certain valuation techniques may cause an award with
a graded vesting schedule to be characterized as multiple awards instead of a single award. (See ASC
718-20-55-25 through 55-34 [Case B: Share Options With Graded Vesting] for an example of the type
of valuation techniques that may cause an award with a graded vesting schedule to be characterized
as multiple awards, and see Section 4.10 for more information about the valuation of awards with
a graded vesting schedule.) Notwithstanding its use of such valuation techniques, the entity can still
make an accounting policy election to record compensation cost on a straight-line basis over the total
requisite service period for the entire award. If straight-line attribution is used, however, ASC 718-10-
35-8 requires that “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.” The examples below illustrate
the attribution of compensation cost under a straight-line method for graded vesting awards.
84
Example 3-15
Entity A grants 1,000 stock options to each of its 100 employees. The grant-date fair-value-based measure of
each option is $12. The options vest in 25 percent increments (tranches) each year over the next four years
(i.e., a graded vesting schedule). To determine the grant-date fair-value-based measure, A uses a valuation
technique in which the award is treated as a single award rather than as multiple awards. Entity A has elected,
as an accounting policy, to estimate the amount of total stock options for which the requisite service period
will not be rendered. Assume that no employees will leave in year 1, three employees will leave in year 2, five
employees will leave in year 3, and seven employees will leave in year 4.
Entity A elected, as an accounting policy, to use the straight-line attribution method to recognize compensation
cost. Under this method, the award is treated as a single award.
The following table summarizes the calculation of total compensation cost by taking into account the estimated
forfeitures noted above:
Total Cost
Tranche 1 (100 × 1,000 × 25% × $12) $ 300,000
Tranche 2 (97 × 1,000 × 25% × $12) 291,000
Tranche 3 (92 × 1,000 × 25% × $12) 276,000
Tranche 4 (85 × 1,000 × 25% × $12) 255,000
Total compensation cost $ 1,122,000
On the basis of the calculation of total compensation cost above, A should recognize $280,500 ($1,122,000
total compensation cost ÷ 4 years of service) of compensation cost each year over the next four years under
the straight-line attribution method for the aggregate 93,500 options that are expected to vest. However,
because, at the end of the first, second, and third years, 25,000, 24,250, and 23,000 employee stock options
have legally vested, A would have to ensure that, at a minimum, $300,000, $591,000 ($300,000 + $291,000),
and $867,000 ($300,000 + $291,000 + $276,000) of cumulative compensation cost is recognized at the end of
the first, second, and third years, respectively. Accordingly, A would recognize $300,000 of compensation cost
in year 1, $291,000 in year 2, $276,000 in year 3, and $255,000 in year 4, rather than the $280,500 that would
have been recognized under a straight-line attribution method. Note that if A’s estimate of forfeitures changes,
the cumulative effect of that change on current and prior periods would be recognized as compensation cost in
the period of the change.
Example 3-16
Assume the same facts as in the example above, except that the options vest over three years in increments
(tranches) of 50 percent for the first year of service, 25 percent for the second year of service, and 25 percent
for the third year of service (i.e., a graded vesting schedule).
The following table summarizes the calculation of total compensation cost by taking into account the estimated
forfeitures noted above:
Total Cost
Tranche 1 (100 × 1,000 × 50% × $12) $ 600,000
Tranche 2 (97 × 1,000 × 25% × $12) 291,000
Tranche 3 (92 × 1,000 × 25% × $12) 276,000
85
On the basis of the calculation of total compensation cost above, Entity A should recognize $389,000
($1,167,000 total compensation cost ÷ 3 years of service) of compensation cost each year over the next three
years under the straight-line attribution method for the aggregate 97,250 options that are expected to vest.
However, because, at the end of the first and second years, 50,000 and 24,250 employee stock options have
legally vested, A would have to ensure that a minimum of $600,000 and $891,000 ($600,000 + $291,000) of
cumulative compensation cost is recognized at the end of the first and second years, respectively. Accordingly,
A would recognize $600,000 of compensation cost in year 1, $291,000 in year 2, and $276,000 in year 3, rather
than the $389,000 that would have been recognized under a straight-line attribution method. Note that if A’s
estimate of forfeitures changes, the cumulative effect of that change on current and prior periods would be
recognized as compensation cost in the period of the change.
The examples below illustrate the attribution of compensation cost under the graded vesting (i.e.,
accelerated) attribution model for graded vesting awards.
Example 3-17
Entity A grants 1,000 stock options to 100 employees, each with a grant-date fair-value-based measure of $12.
The options vest in 25 percent increments (tranches) each year over the next four years (i.e., a graded vesting
schedule). To determine the grant-date fair-value-based measure, A used a valuation technique that treated
the award as a single award rather than as multiple awards. Entity A has elected, as an accounting policy, to
estimate the amount of total stock options for which the requisite service period will not be rendered. Assume
that no employee will leave in year 1, three employees will leave in year 2, five employees will leave in year 3,
and seven employees will leave in year 4.
Entity A elected, as an accounting policy, to use the graded vesting attribution method to recognize
compensation cost. Under the graded vesting attribution method, each tranche that vests separately is treated
as an individual award. In this example, since a portion of the options vests annually, there are four tranches
(i.e., four separate awards). However, if 1/48 of the options vested each month over a four-year period, the
grant would contain 48 separate tranches (i.e., 48 separate awards).
The following table summarizes the calculation of total compensation cost by tranche:
Total Cost
Tranche 1 (100 × 1,000 × 25% × $12) $ 300,000
Tranche 2 (97 × 1,000 × 25% × $12) 291,000
Tranche 3 (92 × 1,000 × 25% × $12) 276,000
Tranche 4 (85 × 1,000 × 25% × $12) 255,000
The table below summarizes the allocation of total compensation cost over each of the four years of service.
Award Year 1 Year 2 Year 3 Year 4 Total Cost
Tranche 1 (300,000 × 1/1) $ 300,000 — — — $ 300,000
Tranche 2 (291,000 × 1/2) 145,500 $ 145,500 — — 291,000
Tranche 3 (276,000 × 1/3) 92,000 92,000 $ 92,000 — 276,000
Tranche 4 (255,000 × 1/4) 63,750 63,750 63,750 $ 63,750 255,000
Total compensation cost $ 601,250 $ 301,250 $ 155,750 $ 63,750 $ 1,122,000
86
Example 3-18
Assume the same facts as in the example above, except that the options vest over three years in increments
(tranches) of 50 percent for the first year of service, 25 percent for the second year of service, and 25 percent
for the third year of service (i.e., a graded vesting schedule).
The following table summarizes the calculation of total compensation cost by tranche:
Total Cost
Tranche 1 (100 × 1,000 × 50% × $12) $ 600,000
Tranche 2 (97 × 1,000 × 25% × $12) 291,000
Tranche 3 (92 × 1,000 × 25% × $12) 276,000
The table below summarizes the allocation of total compensation cost over each of the three years of service.
Award Year 1 Year 2 Year 3 Total Cost
Tranche 1 (600,000 × 1/1) $ 600,000 — — $ 600,000
Tranche 2 (291,000 × 1/2) 145,500 $ 145,500 — 291,000
Tranche 3 (276,000 × 1/3) 92,000 92,000 $ 92,000 276,000
Total compensation cost $ 837,500 $ 237,500 $ 92,000 $ 1,167,000
For a graded vesting award with both a service and a performance condition or a market condition, an
entity is generally precluded from using a straight-line attribution method over the requisite service
period for the entire award. ASC 718-10-35-5 requires an entity to treat awards with graded vesting
as, in substance, multiple awards with more than one requisite service period, and ASC 718-10-35-8
provides an exception to that requirement for awards with “only service conditions.” Accordingly, ASC
718-10-35-8 cannot be applied broadly to awards that contain conditions beyond service conditions.
However, on the basis of discussions with the FASB staff, we believe that ASC 718 does not intend to
preclude straight-line attribution when the only performance condition is a change in control or an
IPO that accelerates vesting when the awards otherwise vest solely on the basis of service conditions.
Although ASC 718-10-35-8 outlines two acceptable methods for recognizing compensation cost for
graded vesting awards “with only service conditions,” we believe that the two acceptable methods
can also be applied when the performance condition is related to a change in control or an IPO that
accelerates vesting when the awards otherwise vest solely on the basis of service conditions.
As discussed in Section 3.4.2.1, (1) it is generally not probable that an IPO will occur until the IPO is
effective and (2) if it is not probable that an IPO performance condition will be met, an entity should
disregard that condition in determining the requisite service period. Similarly, it generally2 is not
probable that a change in control will occur until the change in control is consummated. When the
change in control or IPO performance condition accelerates (but does not preclude) vesting, the
performance condition generally does not affect vesting or the related attribution method unless
a change in control or IPO occurs. Therefore, an entity may elect to apply a straight-line attribution
method for graded vesting awards with service conditions and a change in control or IPO performance
2
One exception to the probability assessment is when the performance condition is related to a change in control event associated with an entity’s
sale of its business unit (or subsidiary) to a third party. See Section 3.4.2.1 for further discussion.
87
condition that accelerates vesting. If the change in control or IPO becomes effective, the awards would
accelerate vesting, and the entity would recognize the remaining compensation cost upon occurrence.
It may not be appropriate to recognize compensation cost for a graded vesting award with only a service
condition by using an approach in which the compensation cost recognized in a given reporting period
is aligned with the percentage of awards that are legally vesting in that reporting period. Specifically,
the use of this method is not acceptable when a graded vesting award with only a service condition
has a back-loaded vesting schedule (e.g., an award that vests 25 percent in year 1, 25 percent in year
2, and 50 percent in year 3). Such a recognition method could result in an entity’s delaying a portion
of compensation cost toward the latter part of the requisite service period. ASC 718-10-35-8 provides
just two acceptable approaches for recognizing compensation cost for a graded vesting award with
only a service condition: (1) straight-line attribution and (2) accelerated attribution. The examples below
illustrate the differences between the methods.
Example 3-19
Assumptions
Grant: 1,000 options
Fair-value-based measure: $10 per option
Vesting: Year 1: 25%, Year 2: 25%, and Year 3: 50%
Total compensation cost: 1,000 × $10 = $10,000
Straight-Line Attribution Method

Under this method, the three tranches are treated as one award and the total compensation cost is recognized
on a straight-line basis over the three-year service period.
Year 1 $ 3,333
Year 2 3,333
Year 3 3,334
Total $ 10,000
Accelerated Attribution Method

Under this method, each tranche is treated as a separate award, and the total compensation cost is recognized
on an accelerated basis over the three-year service period.
Year 1 Year 2 Year 3 Total
Tranche 1 $ 2,500 — — $ 2,500
Tranche 2 1,250 $ 1,250 — 2,500
Tranche 3 1,666 1,667 $ 1,667 5,000
Total $ 5,416 $ 2,917 $ 1,667 $ 10,000
88
Unacceptable Attribution Method

Under this method (which is not acceptable), compensation cost is recognized for the portion of the award that
legally vests in a particular period.
Year 1 $ 2,500
Year 2 2,500
Year 3 5,000
Total $ 10,000
Comparison of Methods
Year 1 Year 2 Year 3
Straight-line attribution method $ 3,333 $ 3,333 $ 3,333
Accelerated attribution method 5,416 2,917 1,667
Unacceptable attribution method 2,500 2,500 5,000
An entity’s use of either a straight-line or an accelerated attribution method represents an accounting

policy election and thus should be applied consistently to all similar awards (e.g., all employee share-
based payment awards subject to graded vesting and with only service conditions). When contemplating
making changes to its accounting policy, an entity must apply ASC 250, including its requirement that
the new recognition policy be preferable to the existing one. ASC 718 does not specify which attribution
method is preferable. Therefore, the preferability assessment should be based on the entity’s specific
facts and circumstances.
3.6.6 Nonsubstantive Service Condition for Employee Awards

3.6.6.1 Retirement Eligibility
ASC 718-10
Illustrations
Example 1: Estimating the Employee’s Requisite Service Period
55-86 This Example illustrates the guidance in paragraphs 718-10-30-25 through 30-26.
55-87 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.
55-88 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.
89
In some cases, an entity may grant share-based payment awards with an explicit service condition to
employees who are eligible for retirement as of the grant date. These awards may contain a clause that
allows an employee who is retirement-eligible (or who becomes retirement-eligible) to (1) retain the
award and (2) continue to vest in the award after the employee retires.
The existence of a retirement provision such as that described above causes the explicit service
condition to become nonsubstantive. ASC 718-10-20 defines the “terms of a share-based payment
award” as follows, in part:
The substantive terms of a share-based payment award . . . provide the basis for determining the rights
conveyed to a party and the obligations imposed on the issuer, regardless of how the award and related
arrangement, if any, are structured.
Because the retirement-eligible employee is not required to provide services during the explicit service
period, the explicit service condition is not considered substantive and does not affect the requisite
service period of the award. The entity has granted an award that does not contain any vesting
conditions and is effectively fully vested on the grant date. Accordingly, the award’s entire grant-date fair-
value-based measure should be recognized as compensation cost on the grant date.
The award may contain a provision that delays the ability to sell or exercise the award through the
end of the explicit service period. However, because the employee is not required to provide services
after becoming retirement-eligible, such a provision represents a postvesting transfer restriction or
exercisability condition and does not change the requisite service period of the award.
Example 3-20
On January 1, 20X1, an entity grants 1,000 at-the-money employee stock options, each with a grant-date
fair value of $6, to employees who are currently retirement-eligible. The awards legally vest and become
exercisable after three years of service. The terms of the award also stipulate that the employees continue to
vest after a qualifying retirement, as defined in their employment agreements. Because the employees are
retirement-eligible on the grant date, the entity should recognize compensation cost of $6,000 immediately
on the grant date, since the employees are not required to work during the stated service period to earn the
award.
Example 3-21
On January 1, 20X1, an entity grants 1,000 at-the-money employee stock options, each with a grant-date fair
value of $6, to employees who will become retirement-eligible two years later on December 31, 20X2. The
awards legally vest and become exercisable after three years of service. The terms of the award also stipulate
that the employees continue to vest after a qualifying retirement, as defined in their employment agreements.
Because the employees are retirement-eligible two years after the grant on December 31, 20X2, the entity
should recognize compensation cost of $6,000 over the two-year period from the grant date (January 1, 20X1)
to the date on which the employees become retirement-eligible (December 31, 20X2), since the employees are
not required to provide employee services during the remainder of the stated service period (January 1, 20X3,
through December 31, 20X3) to earn the award.
3.6.6.2 Noncompete Agreements
ASC 718-20
Example 10: Share Award With a Clawback Feature

55-84 This Example illustrates the guidance in paragraph 718-20-35-2.
90
55-84A This Example (see paragraphs 718-20-55-85 through 55-86) describes employee awards. However,
the principles on how to account for the various aspects of employee awards, except for the compensation
cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, the
accounting for a contingent feature (such as a clawback) of an award that might cause a grantee to return to
the entity either equity instruments earned or realized gains from the sale of the equity instruments earned
is equally applicable to nonemployee awards with the same feature as the awards in this Example (that is, the
clawback feature). Therefore, the guidance in this Example also serves as implementation guidance for similar
nonemployee awards.
55-84B Compensation cost attribution for awards to nonemployees may be the same or different for employee
awards. 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 this Example 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 payment
transactions.
55-85 On January 1, 20X5, Entity T grants its chief executive officer an award of 100,000 shares of stock
that vest upon the completion of 5 years of service. The market price of Entity T’s stock is $30 per share
on that date. The grant-date fair value of the award is $3,000,000 (100,000 × $30). The shares become
freely transferable upon vesting; however, the award provisions specify that, in the event of the employee’s
termination and subsequent employment by a direct competitor (as defined by the award) within three years
after vesting, the shares or their cash equivalent on the date of employment by the direct competitor must be
returned to Entity T for no consideration (a clawback feature). The chief executive officer completes five years
of service and vests in the award. Approximately two years after vesting in the share award, the chief executive
officer terminates employment and is hired as an employee of a direct competitor. Paragraph 718-10-55-8
states that contingent features requiring an employee to transfer equity shares earned or realized gains from
the sale of equity instruments earned as a result of share-based payment arrangements to the issuing entity for
consideration that is less than fair value on the date of transfer (including no consideration) are not considered
in estimating the fair value of an equity instrument on the date it is granted. Those features are accounted for if
and when the contingent event occurs by recognizing the consideration received in the corresponding balance
sheet account and a credit in the income statement equal to the lesser of the recognized compensation cost
of the share-based payment arrangement that contains the contingent feature ($3,000,000) and the fair value
of the consideration received. This guidance does not apply to cancellations of awards of equity instruments as
discussed in paragraphs 718-20-35-7 through 35-9. The former chief executive officer returns 100,000 shares
of Entity T’s common stock with a total market value of $4,500,000 as a result of the award’s provisions. The
following journal entry accounts for that event.
Treasury stock $4,500,000

Other income $3,000,000
To recognize the receipt of consideration as a result of the clawback
feature.
55-86 If instead of delivering shares to Entity T, the former chief executive officer had paid cash equal to the
total market value of 100,000 shares of Entity T’s common stock, the following journal entry would have been
recorded.
Cash $4,500,000
feature.
91
Example 11: Certain Noncompete Agreements and Requisite Service for Employee Awards
55-87 Paragraphs 718-10-25-3 through 25-4 require that the accounting for all share-based payment
transactions with employees or others 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.
Some share-based compensation arrangements with employees may contain noncompete provisions. Those
noncompete provisions may be in-substance service conditions because of their nature. Determining whether
a noncompete provision or another type of provision represents an in-substance service condition is a
matter of judgment based on relevant facts and circumstances. This Example illustrates a situation in which a
noncompete provision represents an in-substance service condition.
55-88 Entity K is a professional services firm in which retention of qualified employees is important in sustaining
its operations. Entity K’s industry expertise and relationship networks are inextricably linked to its employees; if
its employees terminate their employment relationship and work for a competitor, the entity’s operations may
be adversely impacted.
55-89 As part of its compensation structure, Entity K grants 100,000 restricted share units to an employee on
January 1, 20X6. The fair value of the restricted share units represents approximately four times the expected
future annual total compensation of the employee. The restricted share units are fully vested as of the date of
grant, and retention of the restricted share units is not contingent on future service to Entity K. However, the
units are transferred to the employee based on a 4-year delayed-transfer schedule (25,000 restricted share
units to be transferred beginning on December 31, 20X6, and on December 31 in each of the 3 succeeding
years) if and only if specified noncompete conditions are satisfied. The restricted share units are convertible
into unrestricted shares any time after transfer.
55-90 The noncompete provisions require that no work in any capacity may be performed for a competitor
(which would include any new competitor formed by the employee). Those noncompete provisions lapse with
respect to the restricted share units as they are transferred. If the noncompete provisions are not satisfied,
the employee loses all rights to any restricted share units not yet transferred. Additionally, the noncompete
provisions stipulate that Entity K may seek other available legal remedies, including damages from the
employee. Entity K has determined that the noncompete is legally enforceable and has legally enforced similar
arrangements in the past.
55-91 The nature of the noncompete provision (being the corollary condition of active employment), the
provision’s legal enforceability, the employer’s intent to enforce and past practice of enforcement, the delayed-
transfer schedule mirroring the lapse of noncompete provisions, the magnitude of the award’s fair value in
relation to the employee’s expected future annual total compensation, and the severity of the provision limiting
the employee’s ability to work in the industry in any capacity are facts that provide a preponderance of evidence
suggesting that the arrangement is designed to compensate the employee for future service in spite of the
employee’s ability to terminate the employment relationship during the service period and retain the award
(assuming satisfaction of the noncompete provision). Consequently, Entity K would recognize compensation
cost related to the restricted share units over the four-year substantive service period.
92
55-92 Example 10 (see paragraph 718-20-55-84) provides an illustration of another noncompete agreement.
That Example and this one are similar in that both noncompete agreements are not contingent upon
employment termination (that is, both agreements may activate and lapse during a period of active
employment after the vesting date). A key difference between the two Examples is that the award recipient
in that Example must provide five years of service to vest in the award (as opposed to vesting immediately).
Another key difference is that the award recipient in that Example receives the shares upon vesting and may
sell them immediately without restriction as opposed to the restricted share units, which are transferred
according to the delayed-transfer schedule. In that Example, the noncompete provision is not deemed to be
an in-substance service condition. In making a determination about whether a noncompete provision may
represent an in-substance service condition, the provision’s legal enforceability, the entity’s intent to enforce
the provision and its past practice of enforcement, the employee’s rights to the instruments such as the right to
sell them, the severity of the provision, the fair value of the award, and the existence or absence of an explicit
employee service condition are all factors that shall be considered. Because noncompete provisions can be
structured differently, one or more of those factors (such as the entity’s intent to enforce the provision) may be
more important than others in making that determination. For example, if Entity K did not intend to enforce the
provision, then the noncompete provision would not represent an in-substance service condition.
Some awards may contain noncompete provisions that require an employee to forfeit stock options,
return shares, or return any gain realized on the sale of the options or shares if the employee goes to
work for a competitor within a specified period. Generally, the existence of a noncompete provision
does not create an in-substance service condition that an entity must consider in determining the
requisite service period of an award.
The existence of a noncompete provision alone does not result in an in-substance service condition. For
a noncompete provision to represent an in-substance service condition, the provision must compel the
individual employee to provide future services to the entity to receive the benefits of the award. Further,
it must be so restrictive that the employee is unlikely to be able to terminate and retain the award
because any new employment opportunity the individual would reasonably pursue would result in the
award’s forfeiture.
The evaluation of whether a noncompete arrangement creates an in-substance service condition goes
beyond the determination that the noncompete arrangement is a substantive agreement. An entity
must consider all other terms of the award when determining the requisite service period (e.g., whether
the explicit service period is nonsubstantive). The entity should consider the following factors when
determining whether the noncompete arrangement creates an in-substance service condition:
• The nature and legal enforceability of the arrangement.

• The lack of an explicit service condition.
• The employee’s rights under the arrangement (e.g., the right to sell).
• The entity’s intent to enforce the arrangement, and its past practice of enforcement.
• The expiration of any transferability or exercisability restriction mirroring the lapse of the
arrangement.
• The nature of the entity’s operations, industry, and employee relationships.

• The award’s fair value relative to the employee’s expected future annual total compensation.
• Limitations on the employee’s ability to work in the industry in any capacity.
93
In Example 11 in ASC 718-20-55-87 through 55-92, the noncompete arrangement represents an

in-substance service condition because the outcome for the employee would be essentially the same if
there was an explicit vesting period. Although the award was fully vested, compensation cost would be
recognized over the term of the noncompete agreement. However, at a meeting of the FASB Statement
123(R) Resource Group, the FASB staff indicated that Example 11 was intended to be an anti-abuse
provision that would apply in limited circumstances and that an entity must use judgment in evaluating
whether a noncompete provision represents an in-substance service condition. Accordingly, we believe
that it would be rare for a noncompete arrangement to represent an in-substance service condition.
Example 10 in ASC 718-20-55-84 through 55-86 illustrates a situation in which the existence of a
noncompete arrangement does not compel the employee to provide services and therefore does
not result in an in-substance service condition that would affect the requisite service period. The
noncompete provision is treated as a clawback feature (see Section 3.9) if and when the employee
violates the provision and returns the award or its cash equivalent. The entity does not consider the
existence of the provision in determining the requisite service period, and the award is recognized on
the basis of the stated vesting terms. In Example 10, if the award were fully vested, or if the employee
were retirement-eligible and the award continued to vest after retirement or was allowed to immediately
vest upon retirement (see Section 3.6.6.1), compensation cost would be recognized immediately.
3.6.6.3 Deep Out-of-the-Money Stock Options

ASC 718-10
Estimating the Employee’s Requisite Service Period

55-67 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.
A grant of fully vested, deep out-of-the-money stock options is deemed equivalent to a grant of an award
with a market condition. The stock option awards effectively contain a market condition because the
market price on the grant date is significantly below the exercise price. As a result, the share price must
increase to a level above the exercise price before the employee receives any value from the award.
The market condition would be reflected in the estimate of the fair-value-based measure on the grant
date. Because ASC 718 does not provide guidance on determining whether an option is deep out-of-the-
money, an entity must use judgment in making this determination. Factors that an entity may consider
include those affecting the value of the award (e.g., volatility of the underlying stock, exercise price) and
their impact on the expected period required for the award to become at-the-money.
94
Because the stated service period is zero (i.e., the award is fully vested) and the award contains a market
condition, the requisite service period equals the derived service period associated with the market
condition, which is calculated by using a valuation technique (see Section 3.6.3). The lack of an explicit
service period is nonsubstantive because the employee must continue to work for the entity until the
stock option award is in-the-money to receive any value from the award, since it is customary for awards
to have features that limit exercisability upon termination (the term of the option typically truncates,
such as 30 days after termination). Compensation cost should be recognized over the derived service
period if the requisite service is expected to be rendered, unless the market condition is satisfied on an
earlier date, in which case any unrecognized compensation cost is recognized immediately.
3.7 Multiple Conditions for Employee Awards

ASC 718-10

25-20 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.
25-21 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 718-10-55-60 through 55-63 provide guidance on applying this provision to awards with market,
performance, or service conditions (or any combination thereof).
Performance or Service Conditions

30-12 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 718-20-55-4 through 55-40) and Example 1 (see paragraph 718-30-55-1) provide
illustrations of how compensation cost is recognized for awards with service and performance conditions.
95
55-61A An employee award containing one or more market conditions may have an explicit, implicit, or derived
service period. Paragraphs 718-10-55-69 through 55-79 provide guidance on explicit, implicit, and derived
service periods.
55-62 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.
55-63 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).
96
55-66 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).
Accounting for Awards With Market, Performance, or Service Conditions
(1) Based
on the terms
of the share-based
Yes The award is classified and
payment instrument, is
the instrument a liability accounted for as a liability.
under the provisions
of this Subtopic?
No
Vesting conditions are based

solely on the satisfaction
of performance or service
conditions (or any combination
(1a) Does the award thereof).(b) The award is classified
contain a market No and accounted for as equity
condition (paragraph with reversal of recognized
718-10-55-60)? compensation cost if the
award fails to vest (that is, the
promised good is not delivered
or the service is not rendered)
(paragraph 718-10-55-61).
Yes(a)
Regardless of the nature and

(1b) Is number of conditions that must
exercisability of be satisfied, the existence of
the award based solely a market condition requires
No
on the satisfaction of one or recognition of compensation
more market conditions cost if the good is delivered or
(paragraph the service is rendered, even if
718-10-55-61)? 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 an award, then
Yes compensation cost is recognized
if the good is delivered or the
Compensation cost is recognized service is rendered, regardless of
if the good is delivered or the whether the market, performance,
service is rendered, regardless of or service condition is satisfied
whether the market condition is (paragraphs 718-10-55-62
satisfied (paragraph 718-10-55-61). through 55-63).
(a) The award shall be classified and accounted for as equity. Market conditions are included in the grant-date fair value
estimate of the award.
(b) Performance and service conditions that affect vesting are not included in estimating the grant-date fair value of the
award. Performance and service conditions that affect the exercise price, contractual term, conversion ratio, or other
pertinent factors affecting the fair value of an award are included in estimating the grant-date fair value of the award.
97
55-72 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.
55-73 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.
55-74 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.
55-75 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).
55-76 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.
98
If a share-based payment award contains multiple conditions (service, performance, or market) that
affect a grantee’s ability to vest in or exercise the award, an entity recognizes compensation cost
associated with the award on the basis of whether all or just one of the conditions must be met for the
grantee to vest in or exercise the award. For employee awards, this analysis also affects the requisite
service period. As discussed in Section 3.6, for certain nonemployee awards, an entity may analogize
to the guidance on calculating a requisite service period when that guidance is relevant to the entity’s
determination of whether it should recognize compensation cost. For additional discussion of a
nonemployee’s vesting period, see Section 9.3.2.
The table below contains answers to questions about various scenarios in which an award has two
conditions that affect an employee’s requisite service period and the subsequent recognition of
compensation cost.
Answer if the award consists of:
A market A market A service

condition or a condition and A service condition condition and
performance/ a performance/ or a performance a performance
service condition service condition condition that condition that
that must be met that must be met must be met for must be met for
for the employee for the employee the employee to the employee to
to vest in or to vest in or vest in or exercise vest in or exercise
Question exercise the award exercise the award the award the award
What is the requisite The shortest of The longest of the The shorter of the The longer of the
service period if the derived, implicit, derived, implicit, implicit or explicit implicit or explicit
all performance/ or explicit service or explicit service service period. service period.
service conditions period. period.
are probable?
How is the requisite The derived service Compensation cost The implicit/ Compensation cost
service period period is the is not recorded explicit service is not recorded
affected if one of the requisite service until it is probable period associated until it is probable
performance/service period because that the award will with the other that the award
conditions is not the performance/ vest. However, if an vesting condition will vest. If an
probable? service condition is entity has a policy is the requisite entity has a policy
excluded from the of recognizing service period. of recognizing
assessment of the forfeitures when Since meeting forfeitures when
requisite service they occur, and the performance/ they occur, and
period. However, there is not a service condition is meeting the
If an entity has a performance not probable, it is performance
policy of recognizing condition (i.e., excluded from the condition is
forfeitures when there is a market assessment of the probable, the
they occur, and condition and a requisite service requisite service
there is not a service condition), period. However, period is the
performance the requisite service if an entity has a longer of the
condition (i.e., period is the longer policy of recognizing implicit or explicit
there is a market of the derived or forfeitures when service period.
condition and a explicit service they occur and
service condition), period. the performance
the requisite condition is
service period is probable, the
the shorter of the requisite service
derived or explicit period is the
service period. shorter of the
implicit or explicit
service period.
99
(Table continued)
Answer if the award consists of:
A market A market A service

condition or a condition and A service condition condition and
performance/ a performance/ or a performance a performance
service condition service condition condition that condition that
that must be met that must be met must be met for must be met for
for the employee for the employee the employee to the employee to
to vest in or to vest in or vest in or exercise vest in or exercise
Question exercise the award exercise the award the award the award
Under what The employee is The employee is The employee is The employee
circumstances can expected to forfeit expected to forfeit expected to forfeit is expected to
an entity reverse the award (if an the award (if an the award (if an forfeit the award
previously accrued entity’s policy is to entity’s policy is to entity’s policy is to (if an entity’s policy
compensation estimate forfeitures) estimate forfeitures) estimate forfeitures) is to estimate
cost and record no or actually forfeits or actually forfeits or actually forfeits forfeitures) or
compensation cost the award (if an the award (if an the award (if an actually forfeits
for the award? entity’s policy entity’s policy entity’s policy the award (if an
is to recognize is to recognize is to recognize entity’s policy
forfeitures when forfeitures when forfeitures when is to recognize
they occur) before they occur) before they occur) before forfeitures when
the end of the the end of the the service and they occur) before
derived service derived service performance the service or
period and before period or before conditions are met. performance
the performance/ the performance/ condition is met.
service condition is service condition is
met. met.
Does an entity No, unless the No, unless the N/A N/A
subsequently revise market condition market condition
the initial estimate is met earlier than is met earlier than
of the derived estimated. estimated.
service period on
the basis of updated
assumptions?
Does an entity Yes. Yes. Yes. Yes.

subsequently revise
the estimate of
an implicit service
period for updated
assumptions?
3.7.1 Only One Condition Must Be Met — Employee Awards

If the terms of an award contain multiple conditions but only one condition must be met for an
employee to vest in or exercise the award, the requisite service period is the shortest of the explicit,
implicit, or derived service period because the employee must only remain employed until any one of
the conditions is met. Compensation cost should be recognized over that requisite service period.
If the award contains a service or performance condition and it is not probable that the employee
will meet this condition, the entity should disregard the condition in determining the requisite service
period because the employee can still earn (i.e., vest in) the award upon the satisfaction of the
other conditions. Therefore, a condition that is not expected to be met must be excluded from the
determination of the shortest of the explicit, implicit, or derived service period. However, if an entity has
100
a policy of recognizing forfeitures when they occur, it would not disregard any service condition in the
determination of the requisite service period; rather, the entity would assume that a service condition
would be met unless the award is actually forfeited. If the award is forfeited in the future (on the basis of
the service condition), the service condition can no longer be used as the basis for the requisite service
period.
If an award that is classified as equity includes a market condition and neither that nor any other
condition was ultimately met, compensation cost should still be recorded as long as the employee
provides the requisite service under the derived service period. An entity should not consider the
probability that the market condition will be met when it recognizes compensation cost because a
market condition is not a vesting condition. Rather, it should factor the probability of meeting the market
condition into the fair-value-based measure of the award.
ASC 718-10-55-100 through 55-105 provide an example of an award in which only the market condition
or the service condition must be met for the award to vest.
ASC 718-10
Example 5: Employee Share-Based Payment Award With Market and Service Conditions and Multiple
Service Periods
55-100 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).
55-101 Cases A and B share the following assumptions.
55-102 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.
55-103 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.
Case A: When Only One Condition Must Be Met

55-104 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 718-10-55-72 through 55-73, 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.)
101
55-105 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.
Example 3-22
Service or Performance Condition

On January 1, 20X1, Entity A grants employee stock options that vest upon the earlier of (1) the end of the fifth
year of service (cliff vesting) or (2) A’s obtaining a patent for the prescription drug it is currently developing.
Entity A believes that it is probable that the patent will be obtained at the end of four years. The options contain
an explicit service condition (i.e., the options vest at the end of the fifth year of service) and a performance
condition (i.e., the options vest when the entity obtains a patent for the prescription drug it is currently
developing), with an implicit service period of four years. Because the options vest when either condition is met,
the requisite service period is the shorter of the two service periods: four years.
The implicit service period is simply an estimate. Therefore, if the award becomes exercisable because the
patent is obtained before A’s original estimate of four years, A should immediately record any unrecognized
compensation cost on the date the performance condition is met.
Example 3-23
Service or Market Conditions

On January 1, 20X1, when Entity A’s share price is $25 per share, A grants employee stock options that vest on
the earlier of (1) the end of the fifth year of service (cliff vesting) or (2) an increase in A’s share price to $50 per
share. By using a lattice model valuation technique, A estimates that its share price will reach $50 in four years.
The options contain an explicit service condition (i.e., the options vest at the end of the fifth year of service) and
a market condition (i.e., the options vest if A’s share price increases to $50 per share), with a derived service
period of four years. Because the options vest when either condition is met, the requisite service period is the
shorter of the two service periods: four years. If the options vest sooner because the $50 share price target
is attained before the derived service period of four years, A should immediately record any unrecognized
compensation cost on the date the market condition is met. Conversely, if the options never become
exercisable because the share price target is never achieved, but the employee remains employed for at least
four years, compensation cost should still be recorded.
3.7.2 Multiple Conditions Must Be Met — Employee Awards

If all of the conditions in the terms of an award must be met for an employee to vest in or exercise
the award, the requisite service period is the longest of the explicit, implicit, or derived service period
because the employee must still be employed when the last condition is met. Compensation cost should
be recognized over that requisite service period.
However, when one of the conditions is a service or performance condition, recognition of

compensation cost will depend on the probability that the condition will be met. That is, if it is not
probable that the service or performance condition will be met, no compensation cost should be
recognized.
102
On the other hand, if one of the conditions is a market condition, the entity should not consider the
probability of meeting the market condition when it recognizes compensation cost because a market
condition is not a vesting condition. Rather, the probability of meeting the market condition should
be factored into the fair-value-based measure of the award. See Section 4.5 for a discussion of how a
market condition affects the valuation of a share-based payment award. Even if the market condition is
never met, compensation cost should be recognized if the employee provides the requisite service and
the other vesting conditions are met.
For awards that include a performance condition and a service condition, an entity should consider
the probability that the conditions will be met independently. For example, if it is probable that the
performance condition will be met, the entity should still consider its policy election for forfeiture
estimates with respect to the service condition when recognizing compensation cost. Conversely, if an
entity has a policy of recognizing forfeitures when they occur, it would assume that the service condition
will be met unless the award is actually forfeited. In this case, it considers only the probability of a
performance condition and would recognize compensation cost only if it is probable that such condition
will be met.
Case B in ASC 718-10-55-106 is based on the same facts as in ASC 718-10-55-100 through 55-103 (see
Section 3.7.1) and illustrates an award in which both a market condition and a service condition must be
met for the award to vest.
ASC 718-10
Case B: When Both the Market and Service Condition Must Be Met
55-106 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 718-10-55-72 through 55-73). For example, if the award described in Case A [see
Section 3.7.1] 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.
Example 3-24
Both a Service Condition and a Performance Condition

On January 1, 20X1, Entity A grants employee stock options that vest at the end of the fourth year of service
(cliff vesting). The options can be exercised only by employees who are still employed by the entity when it
successfully completes an IPO.
The options contain an explicit service condition (i.e., the options vest at the end of the fourth year of service)
and a performance condition (i.e., the options can be exercised only upon successful completion of an IPO by
employees who are still employed by A upon the IPO’s completion). Entity A’s treatment of the exercisability
condition should be similar to its treatment of a vesting requirement. Under ASC 718-10-55-76, if the vesting
(or exercisability) of an award is based on the satisfaction of both a service and performance condition, the
entity must initially determine which outcomes are probable and recognize the compensation cost over the
longer of the explicit or implicit service period. Because an IPO generally is not considered to be probable until
the IPO is effective, no compensation cost would be recognized until the IPO occurs. For example, if an IPO
becomes effective on December 31, 20X2, and the four years of service are expected to be rendered upon the
IPO’s becoming effective, A would (1) recognize a cumulative-effect adjustment to compensation cost for the
service that has already been provided (two of the four years) and (2) record the unrecognized compensation
cost ratably over the remaining two years of service.
103
Example 3-25
Both a Service Condition and a Market Condition

On January 1, 20X1, Entity A grants employee stock options that vest if A’s share price is at least $50 and the
employee provides service for at least one year (to exercise the options, the employee must also be employed
when the share price is at least $50). Using a Monte Carlo valuation technique, A estimates that its share price
will reach $50 in three years.
The options contain an explicit service condition (i.e., the options vest at the end of one year of service) and a
market condition (i.e., the options become exercisable if A’s share price is at least $50 per share), with a three-
year derived service period. Because the options vest when both conditions are met, the requisite service
period is the longer of the two service periods — three years. In addition, because a market condition is not a
vesting condition, the market condition should be factored into the fair-value-based measure of the options.
In accordance with ASC 718-10-30-14, as long as the employee provides service for three years, compensation
cost must be recognized regardless of whether the market condition is satisfied.
If, to vest in the award, the employee was not required to be employed at the time the market condition is met,
the derived service period would not be relevant since there would be no requisite service requirement tied to
achievement of the target share price.
Example 3-26
Both a Performance Condition and a Market Condition

On January 1, 20X1, Entity A grants employee stock options that vest if (1) A’s share price is at least $50 and
(2) A’s cumulative net income over the next two annual reporting periods exceeds $12 million. As of January 1,
20X1, A’s share price is $40. By using a Monte Carlo valuation technique, A estimates that its share price will
reach $50 in three years.
The options contain a performance condition (i.e., the options vest if A exceeds $12 million in cumulative net
income over the next two annual reporting periods) and a market condition (i.e., the options vest if A’s share
price is at least $50 per share), with a derived service period of three years. Since the market condition is not a
vesting condition, the market condition should be factored into the fair-value-based measure of the options.
The award’s vesting is based on the satisfaction of both a market condition and a performance condition, and
if it is probable that the performance condition will be satisfied in accordance with ASC 718-10-55-73, the initial
estimate of the requisite service period would generally be the longest of the explicit, implicit, or derived service
period. The performance condition provides an explicit service period of two years. The three-year derived service
period is based on an increase in A’s share price to $50. Since the derived service period of three years represents
the longer of the two service periods, compensation cost would be recognized over that three-year period.
If the market condition is satisfied on an earlier date, any unrecognized compensation cost would be
recognized immediately upon its satisfaction. However, this accelerated service period cannot be shorter
than the explicit service period of two years that is associated with the performance condition. Note that in
accordance with ASC 718-10-25-20, if meeting the performance condition were to become improbable, all
previously recognized compensation cost would be reversed. In addition, if the options never vest because the
share price target is never achieved, but the employee remains employed for at least the derived service period
of three years and the performance condition is satisfied, compensation cost still should be recorded.
If, to vest in the award, the employee was not required to be employed at the time the market condition is met,
the derived service period would not be relevant since there would be no requisite service requirement tied to
achievement of the target share price.
104
Example 3-26A
Both a Performance Condition and a Market Condition — Payoff Matrix

On January 1, 20X1, Entity A grants to its employees 100,000 RSUs with a four-year service period (cliff vesting).
The number of RSUs that vest will be determined at the end of the four-year service period on the basis of
the combination of an EBITDA outcome (performance condition) and a TSR outcome (market condition). The
threshold outcomes for both conditions must be met for the employees to vest in any portion of the award. The
number of RSUs that vest is determined in accordance with the following payoff matrix:
TSR
Threshold Target Max

EBITDA
Max 100% 150% 200%
Target 75% 100% 150%
Threshold 25% 50% 75%
Assume that the grant-date fair-value-based measure of each RSU is $25 (determined by using a Monte
Carlo valuation technique), which incorporates the possible outcomes of the market condition (i.e., the TSR).
Compensation cost is recognized by using the number of shares expected to vest on the basis of (1) the
outcome of the performance condition and (2) the target market condition. If A estimates that the service and
performance conditions will be achieved at the target outcome, total compensation cost would be $2.5 million
(100,000 RSUs × $25 grant-date fair-value-based measure × 100%).
If the outcome of the performance condition is different from the initial estimate, compensation cost is
adjusted. However, compensation cost is not adjusted for changes in the outcome of the market condition,
because the RSUs’ grant-date fair-value-based measure of $25 already takes into account the potential
outcomes of the market condition. For example, if the outcome of the performance condition is the maximum
amount, A would recognize $3.75 million (100,000 RSUs × $25 grant-date fair-value-based measure × 150%) of
compensation cost, irrespective of the outcome of the market condition.
Example 3-26B
Both a Performance Condition and a Market Condition — Two Awards

On January 1, 20X1, Entity A grants to its employees 100,000 RSUs. The number of RSUs earned is based on
(1) a range of A’s revenue growth objectives (performance condition) and (2) a specified stock price objective
(market condition) over the year ending December 31, 20X1.
A revenue growth objective includes a minimum threshold for vesting in 20 percent (20,000) of the RSUs, a
target threshold for vesting in 50 percent (50,000) of the RSUs, and a maximum threshold for vesting in 100
percent (100,000) of the RSUs. If the target or maximum growth objective is met and the stock price objective
is met, the number of RSUs earned will increase by 50 percent. Therefore, up to 150 percent of the awards can
be earned if both (1) the maximum (i.e., 100 percent) revenue growth objective and (2) the stock price objective
are met. If only the minimum growth objective is met, the stock price objective will have no effect on the RSUs
earned.
In this example, unlike the scenario in the previous example, 20,000 RSUs may be earned solely on the basis of
the achievement of the performance condition (i.e., the revenue growth objective). Therefore, the 20,000 RSUs
may be accounted for separately and the grant-date fair-value-based measurement should not incorporate the
market condition associated with the stock price objective because the 20,000 RSUs can be earned and remain
unaffected by whether the stock price objective is achieved if only the minimum growth objective is met.
The remainder of the RSUs may be evaluated separately since they are subject to both a performance
condition and a market condition. If the stock price objective is met, 75,000 or 150,000 RSUs may vest
depending on the outcome of the revenue growth objective. If the stock price objective is not met, 50,000 or
100,000 RSUs may vest depending on the outcome of the revenue growth objective. Determining the grant-
date fair-value-based measure for this portion of the award is challenging, and companies should consult with
their valuation specialists for assistance.
105
3.7.2.1 Liquidity Event and Target IRR

The accounting for share-based payment awards that contain multiple conditions is based on the type
of conditions (service, performance, or market) associated with the awards. For example, certain awards
may vest only if a target IRR to shareholders is achieved while the grantee is employed and the IRR
is based on the payment of sufficient proceeds that result from a liquidity event, dividends, or other
distributions. Attaining a specified IRR is functionally equivalent to achieving a specified rate of return
on an entity’s stock, which is an example of a market condition under ASC 718 (see Section 3.5). Market
conditions are treated as nonvesting conditions that are factored into the fair-value-based measure
of the award. The requirement that the award vest on the basis of sufficient proceeds distributed to
shareholders represents a performance condition under ASC 718 (see Section 3.4.2). Because the
performance condition affects the employee’s ability to earn the award, it is not factored into the award’s
fair-value-based measure. An entity may conclude that a liquidity event would be necessary to generate
sufficient proceeds to meet the IRR target. Therefore, although a liquidity event is not an explicit vesting
condition, the probability that a liquidity event will occur governs whether the performance condition
(e.g., payment of sufficient proceeds) is achieved.
During the service (vesting) period, an entity must assess the probability that any performance condition
(e.g., payment of sufficient proceeds) will be met (i.e., the probability that the employee will earn the
award). For example, if it is not probable that the entity will declare and pay sufficient dividends or
distributions to meet the IRR target, the entity should not record any compensation cost.
An entity generally does not recognize compensation cost related to awards that vest upon certain
liquidity events such as a change in control or an IPO until the event takes place (see Section 3.4.2.1).
That is, a change in control or an IPO is generally not considered probable until it occurs. This position
is consistent with the guidance in ASC 805-20-55-50 and 55-51 on liabilities that are triggered upon the
consummation of a business combination. Note that in circumstances in which it is explicit that the IRR
market condition must be met upon the occurrence of a liquidity event, compensation cost would be
recognized as of the date of the liquidity event regardless of whether the IRR market condition has been
met because a market condition is factored into the fair-value-based measurement of the award.
In determining an award’s requisite service period, an entity must consider the multiple conditions
associated with it. There is an implicit service period for a performance condition associated with a
liquidity event. However, in instances in which the IRR market condition can only be met upon the
occurrence of the liquidity event, the entity does not need to calculate a derived service period to
determine the requisite service period. In that scenario, the implicit service period is determined on the
basis of the expected date of the liquidity event, so the requisite service period would always equal the
implicit service period. However, because the occurrence of a liquidity event is generally not considered
probable until the event has occurred, no compensation cost would be recognized until such time.
3.7.2.2 Multiple Performance Conditions That Affect Vesting and Nonvesting

Factors
If a share-based payment award contains multiple performance conditions that affect both vesting
factors and nonvesting (e.g., exercise price) factors, a grant-date fair-value-based measure should be
calculated for each possible nonvesting condition outcome. If the vesting condition is not expected to
be met, no compensation cost should be recorded. If the vesting condition is expected to be met, the
amount of compensation cost should be based on the grant-date fair-value-based measure associated
with the nonvesting condition outcome whose achievement is probable. This analysis applies to both
employee and nonemployee awards. See Section 4.6 for a discussion of the effect of performance
conditions that affect factors other than vesting or exercisability.
106
Example 3-27
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options with an exercise price of
$10. The options vest in two years if its EBITDA growth rate exceeds the industry average by 10 percent. The
grant-date fair-value-based measure of this option is $3. However, the exercise price will be reduced to $5 if
regulatory approval for Product X is obtained within two years. The grant-date fair-value-based measure of this
option is $6.
The EBITDA target is expected to be achieved by December 31, 20X2, but it is not probable that regulatory
approval will be obtained by that time. Therefore, compensation cost of $1,500 should be recorded in 20X1
(1,000 options × $3 grant-date fair-value-based measure × 50% for one of two years of service provided).
On December 31, 20X2, regulatory approval is obtained and A’s EBITDA target is met. Therefore, in 20X2, A
should recognize compensation cost of $4,500, or (1,000 options × $6 grant-date fair-value-based measure ×
100% of services provided) – $1,500 of compensation cost previously recognized.
3.7.3 Multiple Conditions and Multiple Service Periods — Employee Awards

An award’s terms and conditions can sometimes result in multiple service periods. In such cases, an
entity must evaluate each condition to determine whether there are multiple (1) grant dates, (2) service
inception dates, and (3) service periods. The examples below in ASC 718 illustrate scenarios in which
multiple service periods can exist.
3.7.3.1 Multiple Performance Conditions and Multiple Service Periods

ASC 718-10
Example 3: Employee Share-Based Payment Award With a Performance Condition and Multiple Service
Periods
55-92 The following Cases illustrate employee share-based payment awards with a performance condition (see
paragraphs 718-10-25-20 through 25-21; 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).
55-93 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.
Case A: Performance Targets Are Set at the Inception of the Arrangement

55-94 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.
107
Case B: Performance Targets Are Established at Some Time in the Future

55-95 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.
Case C: Performance Targets Established Up Front but Vesting Is Tied to the Vesting of a Preceding Award
55-96 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.
3.7.3.2 Multiple Service Periods Related to Exercise Price

ASC 718-10
Example 4: Employee Share-Based Payment Award With a Service Condition and Multiple Service Periods
55-97 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).
Case A: Exercise Price Established at Subsequent Dates

55-98 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 718-10-55-80 through 55-83
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.
108
Case B: Exercise Price Established at Inception

55-99 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.
3.7.3.3 Multiple Service Periods Related to Transferability

ASC 718-20
Example 4: Share Option Award With Other Performance Conditions

concepts about valuation, expected term, and total compensation cost that should be recognized (that is, the
consideration of whether it is probable that performance conditions will be achieved) in paragraphs 718-20-
55-48 through 55-50 are equally applicable to nonemployee awards with the same features as the awards in
this Example (that is, awards with performance conditions that affect inputs to an award’s fair value). Therefore,
the guidance in those paragraphs may serve as implementation guidance for similar nonemployee awards.
transactions.
55-48 While performance conditions usually affect vesting conditions, they may affect exercise price,
contractual term, quantity, or other factors that affect an award’s fair value before, at the time of, or after
vesting. This Topic requires that all performance conditions be accounted for similarly. A potential grant-date
fair value is estimated for each of the possible outcomes that are reasonably determinable at the grant date
and associated with the performance condition(s) of the award (as demonstrated in Example 3 [see paragraph
718-20-55-41)]. Compensation cost ultimately recognized is equal to the grant-date fair value of the award that
coincides with the actual outcome of the performance condition(s).
109
55-49 To illustrate the notion described in the preceding paragraph and attribution of compensation cost if
performance conditions have different service periods, assume Entity C grants 10,000 at-the-money share
options on its common stock to an employee. The options have a 10-year contractual term. The share options
vest upon successful completion of phase-two clinical trials to satisfy regulatory testing requirements related to
a developmental drug therapy. Phase-two clinical trials are scheduled to be completed (and regulatory approval
of that phase obtained) in approximately 18 months; hence, the implicit service period is approximately 18
months. Further, the share options will become fully transferable upon regulatory approval of the drug therapy
(which is scheduled to occur in approximately four years). The implicit service period for that performance
condition is approximately 30 months (beginning once phase-two clinical trials are successfully completed).
Based on the nature of the performance conditions, the award has multiple requisite service periods (one
pertaining to each performance condition) that affect the pattern in which compensation cost is attributed.
Paragraphs 718-10-55-67 through 55-79 and 718-10-55-86 through 55-88 provide guidance on estimating the
requisite service period of an award. The determination of whether compensation cost should be recognized
depends on Entity C’s assessment of whether the performance conditions are probable of achievement. Entity
C expects that all performance conditions will be achieved. That assessment is based on the relevant facts and
circumstances, including Entity C’s historical success rate of bringing developmental drug therapies to market.
55-50 At the grant date, Entity C estimates that the potential fair value of each share option under the 2
possible outcomes is $10 (Outcome 1, in which the share options vest and do not become transferable) and
$16 (Outcome 2, in which the share options vest and do become transferable). The difference in estimated fair
values of each outcome is due to the change in estimate of the expected term of the share option. Outcome 1
uses an expected term in estimating fair value that is less than the expected term used for Outcome 2, which
is equal to the award’s 10-year contractual term. If a share option is transferable, its expected term is equal to
its contractual term (see paragraph 718-10-55-29). If Outcome 1 is considered probable of occurring, Entity C
would recognize $100,000 (10,000 × $10) of compensation cost ratably over the 18-month requisite service
period related to the successful completion of phase-two clinical trials. If Outcome 2 is considered probable
of occurring, then Entity C would recognize an additional $60,000 [10,000 × ($16 – $10)] of compensation cost
ratably over the 30-month requisite service period (which begins after phase-two clinical trials are successfully
completed) related to regulatory approval of the drug therapy. Because Entity C believes that Outcome 2 is
probable, it recognizes compensation cost in the pattern described. However, if circumstances change and it is
determined at the end of Year 3 that the regulatory approval of the developmental drug therapy is likely to be
obtained in six years rather than four, the requisite service period for Outcome 2 is revised, and the remaining
unrecognized compensation cost would be recognized prospectively through Year 6. On the other hand, if it
becomes probable that Outcome 2 will not occur, compensation cost recognized for Outcome 2, if any, would
be reversed.
3.8 Changes in Estimate for Employee Awards

ASC 718-10
35-7 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 718-10-55-69 through 55-79 provide guidance on
adjusting the initial estimate of the requisite service period.
110
55-76 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.
55-77 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.
55-78 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).
55-79 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.
The accounting for a change in estimate is based on the cause of the change. Generally, changes in the
requisite service period are accounted for prospectively, while other changes in estimate are accounted
for by using a cumulative-effect adjustment.
111
3.9 Clawback Features
ASC 718-10
30-24 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.
55-8 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.
Contingency Features That Affect the Option Pricing Model

55-47 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.
ASC 718-20
718-10-55-8), shall be accounted for if and when the contingent event occurs. Example 10 (see paragraph
718-20-55-84) provides an illustration of an employee award with a clawback feature.
Example 10: Share Award With a Clawback Feature

accounting for a contingent feature (such as a clawback) of an award that might cause a grantee to return to
the entity either equity instruments earned or realized gains from the sale of the equity instruments earned
is equally applicable to nonemployee awards with the same feature as the awards in this Example (that is, the
clawback feature). Therefore, the guidance in this Example also serves as implementation guidance for similar
nonemployee awards.
112
transactions.
55-85 On January 1, 20X5, Entity T grants its chief executive officer an award of 100,000 shares of stock
that vest upon the completion of 5 years of service. The market price of Entity T’s stock is $30 per share
on that date. The grant-date fair value of the award is $3,000,000 (100,000 × $30). The shares become
freely transferable upon vesting; however, the award provisions specify that, in the event of the employee’s
termination and subsequent employment by a direct competitor (as defined by the award) within three years
after vesting, the shares or their cash equivalent on the date of employment by the direct competitor must be
returned to Entity T for no consideration (a clawback feature). The chief executive officer completes five years
of service and vests in the award. Approximately two years after vesting in the share award, the chief executive
officer terminates employment and is hired as an employee of a direct competitor. Paragraph 718-10-55-8
states that contingent features requiring an employee to transfer equity shares earned or realized gains from
the sale of equity instruments earned as a result of share-based payment arrangements to the issuing entity for
consideration that is less than fair value on the date of transfer (including no consideration) are not considered
in estimating the fair value of an equity instrument on the date it is granted. Those features are accounted for if
and when the contingent event occurs by recognizing the consideration received in the corresponding balance
sheet account and a credit in the income statement equal to the lesser of the recognized compensation cost
of the share-based payment arrangement that contains the contingent feature ($3,000,000) and the fair value
of the consideration received. This guidance does not apply to cancellations of awards of equity instruments as
discussed in paragraphs 718-20-35-7 through 35-9. The former chief executive officer returns 100,000 shares
of Entity T’s common stock with a total market value of $4,500,000 as a result of the award’s provisions. The
following journal entry accounts for that event.
Treasury stock $4,500,000

feature.
55-86 If instead of delivering shares to Entity T, the former chief executive officer had paid cash equal to the total
market value of 100,000 shares of Entity T’s common stock, the following journal entry would have been recorded.
Cash $4,500,000
feature.
Clawback features, as contemplated in ASC 718, are protective provisions that require or permit the
recovery of value transferred to award holders who violate certain conditions. Examples include the
violation of a noncompete or nonsolicitation agreement, termination of employment for cause (e.g.,
because of fraud or noncompliance with company policies), and material restatements of financial
statements. ASC 718-20-35-2 requires that the effect of certain contingent features “such as a clawback
feature . . . be accounted for if and when the contingent event occurs.” ASC 718-20-55-85 states that
contingent features, such as clawback features, “are accounted for . . . by recognizing the consideration
received in the corresponding balance sheet account and a credit in the income statement equal to the
113
lesser of [1] the recognized compensation cost of the share-based payment [award] that contains the
contingent feature . . . and [2] the fair value of the consideration received.” By contrast, in the absence
of a clawback feature, a credit to the income statement is not recorded for vested awards (i.e., those for
which the grantee has provided the required goods or services for earning the award) even if the awards
are canceled or expire unexercised. Many share-based payment awards contain provisions requiring
grantees to exercise vested stock option awards within a specified period after termination (i.e., the
contractual term of the awards is truncated). Awards not exercised within the specified period expire.
The requirement to forfeit vested awards after a specified period because the vested awards are
not exercised before their expiration is not considered a clawback feature. In accordance with ASC
718-10-35-3, entities are prohibited from accounting for these types of provisions as clawback features
and from reversing the compensation cost for vested awards that are returned because they expire
unexercised.
Example 3-28
On January 1, 20X1, Entity A grants to its CEO 1 million at-the-money employee stock options, each with a grant-
date fair-value-based measure of $6. The options vest at the end of the fourth year of service (cliff vesting).
However, the options contain a provision that requires the CEO to return vested options, including any gain
realized by the CEO related to vested and previously exercised options, to the entity for no consideration if
the CEO terminates employment to work for a competitor any time within six years of the grant date. The CEO
completes four years of service and exercises the vested options. Entity A has recognized total compensation
cost of $6 million (1 million options × $6 grant-date fair-value-based measure) over the four-year service period.
Approximately one year after the options vest, the CEO terminates employment and is hired as an employee of
a direct competitor. Because of the options’ provisions, the former CEO returns 1 million shares of A’s common
stock with a total fair value of $3 million. Entity A records the amounts below on the date the clawback feature
is enforced.
Journal Entry
Treasury stock 3,000,000

Other income 3,000,000
To record other income for the consideration received as a result of
the clawback feature.
Alternatively, assume that in accordance with the options’ provisions, the former CEO returns 1 million shares of
A’s common stock with a total fair value of $7.5 million. Since the fair value of the shares returned ($7.5 million)
is greater than the compensation cost previously recorded ($6 million), an amount equal to the compensation
cost previously recorded would be recorded as other income. The difference ($1.5 million) would be recorded
as an increase to paid-in capital. See the journal entry below.
Journal Entry
Treasury stock 7,500,000

Other income 6,000,000
APIC 1,500,000
To record other income and return of capital (for the consideration
received in excess of compensation cost previously recognized) as
a result of the clawback feature.
114
Section 3.4.3 discusses share-based payment awards that have repurchase features that function, in
substance, as vesting conditions (i.e., forfeiture provisions). Similarly, some awards have repurchase
features that function, in substance, as clawback features. For example, a feature is substantively a
clawback feature if it gives an entity the option to repurchase a grantee’s share-based payment award
for (1) cost (which often is zero or, for options, the exercise price) or (2) the lesser of the fair value of
the shares on the repurchase date or the cost of the award if, for example, an employee is terminated
for cause. Such a repurchase feature is a protective clause, not a forfeiture provision, because it does
not create an in-substance service condition in the event, for example, the employee is terminated for
cause. A repurchase feature that functions as a clawback feature does not affect the balance sheet
classification for awards (i.e., liability versus equity). It is instead recognized if and when the contingent
event occurs (e.g., an employee is terminated for cause).
Example 3-29
Entity A grants 1,000 stock awards to an employee that vest at the end of the second year of service (cliff
vesting). However, if the employee is terminated at any time by A for cause, A has the right to call the shares at
cost.
The repurchase feature (i.e., the call option) functions as an in-substance clawback feature. This type of
repurchase feature is not a forfeiture provision because it does not create an in-substance service condition;
rather, it is a protective clause that applies if the employee is terminated for cause. Accordingly, the requisite
service period is the explicitly stated vesting period of two years.
3.10 Dividend Protected Awards

ASC 718-10
55-45 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.
The terms of some share-based payment awards permit holders to receive a dividend during the vesting
period and, in some instances, to retain the dividend even if the award fails to vest. Such awards are
commonly referred to as “dividend-protected awards.”
The accounting for dividends paid on dividend-protected equity-classified awards is based on the
manner in which the entity has elected to account for forfeitures.3 If the entity elects, as an accounting
policy, to estimate the number of awards expected to be forfeited, the entity should, in a manner
consistent with the forfeiture estimate it uses to recognize compensation cost of an award, charge to
retained earnings the dividend payment for dividend-protected awards to the extent that the award
3
As discussed in Section 3.4.1, an entity can make a different accounting policy election between employee and nonemployee awards to either
estimate forfeitures or account for forfeitures when they occur.
115
is expected to vest. Such dividends are recognized in retained earnings to prevent their being double-
counted as compensation cost since dividends are already factored into the grant-date fair-value-based
measure of the awards. If a grantee is entitled to retain dividends paid on shares that fail to vest, the
dividend payment for dividend-protected awards that are not expected to vest should be charged
to compensation cost and then periodically adjusted on the basis of any revisions to the forfeiture
estimate, with a final true-up based on actual forfeitures.
However, if an entity elects as an accounting policy to account for forfeitures as they occur, all dividends
paid on dividend-protected equity-classified awards (i.e., both forfeitable and nonforfeitable dividends)
are initially charged to retained earnings and, if nonforfeitable, reclassified to compensation cost if and
when forfeitures of the underlying awards occur.
While ASC 718 does not specifically address the appropriate treatment of dividend-protected liability-
classified awards, we believe that by analogy to ASC 480-10-55-14 and ASC 480-10-55-28, such
dividends should be recognized as compensation cost.
ASC 718-740-45-8 indicates that if an entity receives a tax deduction for dividends paid, any income tax
expense or benefit related to dividend or dividend equivalents paid to grantees must be recognized in
the income statement, even if charged to retained earnings.
An entity that uses an option-pricing model to estimate the fair-value-based measure of a stock option
usually takes expected dividends into account because dividends paid on the underlying shares are part
of the fair value of those shares, and option holders generally are not entitled to receive those dividends.
However, for dividend-protected awards, the entity should appropriately reflect that dividend protection
in estimating the fair-value-based measure of a stock option. For example, an entity could appropriately
reflect the effect of the dividend protection by using an expected dividend yield input of zero if all
dividends paid to shareholders are applied to reduce the exercise price of the options being valued.
Note that if any dividends are nonforfeitable, the awards would be considered “participating securities”
in the EPS calculation. See Section 12.4.3 for a discussion of the effect of dividend-paying share-based
payment awards on the computation of EPS. Further note that irrespective of whether an award is
dividend-protected, the accounting for a large, nonrecurring cash dividend for an equity-classified award
in connection with an equity restructuring differs from the accounting discussed above and may result in
both a partial settlement of vested awards and a partial modification from equity to liability classification
of unvested awards, as illustrated in Example 6-31A in Section 6.10.2.
Example 3-30
value-based measure of $100. The options vest at the end of one year of service (cliff vesting). The option
holders will receive a cash amount per option that is equal to the dividends paid per share to common
shareholders during the vesting period. Employees are not required to return the dividends received if
they forfeit their options. On July 1, 20X1, A declares a dividend of $1 per share. Entity A has elected as an
accounting policy to estimate the number of awards expected to be forfeited, and it has estimated a forfeiture
rate of 10 percent. See the journal entries below.
Journal Entry: March 31, 20X1
Compensation cost 22,500

APIC 22,500
To record compensation cost for the quarter ended March 31, 20X1
(1,000 options × $100 fair-value-based measure × 25% services
rendered × 90% of options expected to vest).
116
Journal Entry: June 30, 20X1

APIC 22,500
To record compensation cost for the quarter ended June 30, 20X1
(1,000 awards × $100 fair-value-based measure × 25% services
rendered × 90% of options expected to vest).
Journal Entry: Date of Dividend Declaration
Retained earnings 900

Dividends payable 1,000
To record the declaration of cash dividends and the related

compensation cost on options not expected to vest (1,000 options
× $1 dividend × 10% of dividends paid on options not expected to
vest).
Journal Entry: September 30, 20X1

APIC 22,500
To record compensation cost for the quarter ended September
30, 20X1 (1,000 options × $100 fair-value-based measure × 25%
services rendered × 90% of options expected to vest).
In the fourth quarter, A experiences lower turnover than expected. On December 31, 20X1, 980 of the 1,000
options that were granted become vested. On that date, A would record the journal entries below.

APIC 30,500
To record compensation cost for the quarter ended December
31, 20X1 [(980 options vested × $100 fair-value-based measure) –
$67,500 compensation cost previously recognized].
To adjust compensation cost for dividends paid on awards that
the company believed would be forfeited but vested [(20 options
forfeited × $1 dividend) – $100 compensation cost previously
recognized].
117
In the journal entries below, assume the same facts as those above except that Entity A has elected as an
accounting policy to account for forfeitures as they occur.
Journal Entry: March 31, 20X1

APIC 25,000
To record compensation cost for the quarter ended March 31, 20X1
rendered).
Journal Entry: June 30, 20X1

APIC 25,000
To record compensation cost for the quarter ended June 30, 20X1
rendered).
Journal Entry: Date of Dividend Declaration
Retained earnings 1,000

Dividend payable 1,000
To record the declaration of cash dividends.
Journal Entry: September 30, 20X1

APIC 25,000
To record compensation cost for the quarter ended September
30, 20X1 (1,000 options × $100 fair-value-based measure × 25%
services rendered).
In the fourth quarter, 20 options were forfeited, and on December 31, 20X1, the remaining 980 of the 1,000
options that were granted become vested. On that date, A would record the journal entries below.

APIC 23,000
To record compensation cost for the quarter ended December
31, 20X1 [(980 options vested × $100 fair-value-based measure) –
$75,000 compensation cost recognized].
To record compensation cost for dividends paid on awards that did
not vest (20 options forfeited × $1 dividend).
118
3.11 Nonrecourse and Recourse Notes

ASC 718-10
An entity may offer financing in the form of a recourse note or a nonrecourse note in connection with
a grantee’s purchase of its shares or the exercise of stock options. A nonrecourse note is a loan that
limits the liability of the holder of the stock being purchased if for any reason the holder defaults on the
note. If, however, the loan was collateralized by more than the stock purchased (e.g., the entity would
seek recovery of the money by claiming personal assets of the grantee), the loan would be considered
a recourse note. The measurement and recognition of an award is based on whether the financing is a
recourse note or a nonrecourse note.
3.11.1 Recourse Notes
If the consideration received from the grantee consists of a recourse note, the transfer of shares is
a substantive purchase of stock or an exercise of an option. If the stated interest rate is less than a
market rate of interest, the exercise or purchase price is equal to the fair value of the note (i.e., the
present value of the principal and interest payments when a discount rate equivalent to a market rate of
interest is used). The impact of a below-market rate of interest would be reflected as a reduction of the
exercise or purchase price and an increase in compensation cost recognized (see the example below).
If the stated interest rate is equal to a market rate of interest, the exercise or purchase price is equal
to the principal of the note. That is, the impact of an at-market rate of interest would have no effect
on the exercise or purchase price and therefore would not result in an increase in compensation cost
recognized.
Example 3-31
An entity indirectly reduces the price of an award when it provides an employee with a non-interest-bearing,
full-recourse note to cover the purchase price of shares. If an employee purchased shares with a fair value of
$20,000 but the entity provided a five-year, non-interest-bearing note (when the market rate of interest was
10 percent), the fair value of the consideration (i.e., the purchase price) is now only $12,418 (the present value
of $20,000 in five years, discounted at 10 percent). A reduction in the purchase price results in an increase in
the grant-date fair-value-based measure of the award and an increase in the amount of compensation cost
recognized. The entity would therefore record compensation cost of $7,582, equal to the $20,000 fair value of
the shares less the $12,418 fair value of the consideration received.
3.11.2 Nonrecourse Notes
If the consideration received from the grantee consists of a nonrecourse note, the award is, or continues
to be, accounted for as an option until the note is repaid. This is because even after the original options
are exercised or the shares are purchased, a grantee could decide not to repay the loan if the value of
the shares declines below the outstanding loan amount and could instead choose to return the shares
in satisfaction of the loan. The result would be similar to a grantee’s electing not to exercise an option
whose exercise price exceeds the current share price.
119
The same result would occur if the nonrecourse note was not for the entire award. For example, a
grantee could exercise 1,000 stock options in exchange for (1) cash equating to the exercise price for
720 of the options and (2) a nonrecourse note for 280 of the options solely to cover the required tax
withholdings. However, only the 280 options exercised in exchange for the nonrecourse note would
continue to be accounted for as options until the note is repaid.
When shares are exchanged for a nonrecourse note, the principal and interest are viewed as part of the
exercise price of the “option” (therefore, no interest income is recognized). If the note bears interest,
the exercise price increases over time by the amount of interest accrued and, accordingly, the option
valuation model must incorporate an increasing exercise price. Further, because the shares sold on
a nonrecourse basis are accounted for as options, the note and the shares are not recorded. Rather,
compensation cost is recognized over the requisite service period or nonemployee’s vesting period,
with an offsetting credit to APIC. Periodic principal and interest payments, if any, are treated as deposits.
Refundable deposits are recorded as a liability until the note is paid off, at which time the deposit
balance is transferred to APIC. Nonrefundable deposits are immediately recorded as a credit to APIC as
payments are received. In addition, the shares would be excluded from basic EPS and included in diluted
EPS in accordance with the treasury stock method until the note is repaid.
Similarly, in exchange for a nonrecourse loan to an employee for personal use, an entity may pay cash
that is collateralized by the entity’s stock already owned by the employee. Although the loan is not
issued in connection with the purchase of shares or the exercise of options, the employee obtains a
right similar to that of a stock option (i.e., the employee will make a decision to either repay the loan and
retain the shares or not repay the loan and forfeit the shares). In this scenario, the entity has effectively
repurchased the employee’s shares in exchange for cash proceeds from the nonrecourse loan and
the grant of an option. Accordingly, the entity would recognize as compensation cost any excess of the
repurchase amount (i.e., the cash proceeds and the fair-value-based measure of the option) over the fair
value of the shares pledged.
3.11.3 Changes Made to the Note

If (1) a grantee is allowed to exercise an option with a note that was not provided for in the terms of
the options when the options were granted, (2) the terms of a note (e.g., interest rate) are changed,
or (3) the note is forgiven, these changes constitute modifications that should be accounted for in
accordance with ASC 718-20-35-2A through 35-3A. See Chapter 6 for a discussion and examples of the
accounting for the modification of a share-based payment award. In addition, a change in the terms, or
forgiveness of, an outstanding recourse note would constitute a modification even if the issued shares
are no longer subject to ASC 718, unless the modification made to the outstanding recourse note
applies equally to all shares of the same class.
Further, the company should reevaluate whether it intends to forgive other outstanding recourse notes
and determine whether such notes should instead be considered in-substance nonrecourse notes. See
the next section for more information.
120
3.11.4 In-Substance Nonrecourse Note

A recourse note issued to a grantee may be an in-substance nonrecourse note. In determining
whether a recourse note is, in substance, a nonrecourse note, entities should consider Issue 34 of
EITF Issue 00-23. Although it was nullified, EITF Issue 00-23 contains guidance that remains relevant on
determining whether a recourse note is substantively a nonrecourse note. It indicates that a recourse
note should be considered nonrecourse if any of the following factors are present:
• The entity has legal recourse to the grantee’s other assets but does not intend to seek
repayment beyond the shares issued.
• The entity has a history of not demanding repayment of loan amounts in excess of the fair value
of the shares.
• The grantee does not have sufficient assets or other means (beyond the shares) of justifying the
recourse nature of the loan.
• The entity has accepted a recourse note upon exercise and subsequently converts the recourse
note to a nonrecourse note.
At an EITF meeting to discuss Issue 00-23, an SEC observer stated that all other relevant facts and
circumstances should be evaluated and that if the note is ultimately forgiven, the SEC will most likely
challenge the appropriateness of a conclusion that the note was a recourse note.
3.11.5 Combination Recourse and Nonrecourse Loan

For tax purposes, a grantee may exercise options by using a nonrecourse note for a portion of the total
exercise price and a recourse note for the remainder. If the respective notes are not distinctly aligned
with a corresponding percentage of the underlying shares (i.e., in a non-pro-rata structure), both notes
should be accounted for together as nonrecourse. A non-pro-rata structure is one in which the share
purchase price or exercise price for each share of stock is represented by both the nonrecourse note
and the recourse note on the basis of their respective percentages of the total exercise price (e.g., 40
percent of the exercise price is nonrecourse and 60 percent of the exercise price is recourse). However,
if the nonrecourse and recourse notes are related to a pro rata portion of the shares (e.g., 40 percent of
the shares correspond to a nonrecourse note, and 60 percent of the shares correspond to a recourse
note), an entity would account for (1) the shares associated with the recourse note as a substantive
exercise of the option and (2) the shares associated with the nonrecourse note as an outstanding
option.
3.12 Employee Payroll Taxes

ASC 718-10
Payroll Taxes
25-22 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).
121
3.13 Capitalization of Compensation Cost

SEC Staff Accounting Bulletins
SAB Topic 14.I, Capitalization of Compensation Cost Related to Share-Based Payment Arrangements
[Excerpt; Reproduced in ASC 718-10-S99-1]
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.94
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
2002,95 is effective.
94
FASB ASC paragraph 718-10-25-2.
95
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.
122
Chapter 4 — Measurement
4.1 Fair-Value-Based Measurement
Fair Value
The amount at which an asset (or liability) could be bought (or incurred) or sold (or settled) in a current
transaction between willing parties, that is, other than in a forced or liquidation sale.
ASC 718-10
General
30-1 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.
Fair-Value-Based
30-2 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.
30-3 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.
30-4 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).
Terms of the Award Affect Fair Value

30-5 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.
123
ASC 718 requires entities to measure compensation cost for share-based payments awarded to
grantees on the basis of the fair value of the equity instruments exchanged or the liabilities incurred.
Such measurement is referred to as a fair-value-based measurement because the entity does not
consider the effects of certain features that it would take into account in a true fair value measurement
in determining the fair value of the share-based payment award. The most significant difference
between the terms “fair value” as defined in ASC 820 and “fair-value-based” as used in ASC 718 is that
the latter term excludes the effects of (1) service and performance conditions that apply only to vesting
or exercisability, (2) reload features, and (3) certain contingent features.
For the rare situations in which fair value is not reasonably estimable (e.g., the terms of an award are
highly complex), ASC 718 provides an exception to fair-value-based measurement under which entities
measure an award at its intrinsic value and remeasure it in each reporting period until settlement. See
Section 4.11 for additional information. Entities may also use a simplified method for determining an
expected term for their options and similar instruments if certain conditions are met. The discussion in
Section 4.9.2.2.2 applies to public entities, and the discussion in Section 4.9.2.2.3 applies to nonpublic
entities.
Further, two other exceptions to fair-value-based measurement are available to nonpublic entities.
Under the first exception, nonpublic entities that cannot reasonably estimate the expected volatility
of their share price for options or similar instruments are required to substitute the historical volatility
of an appropriate industry sector index for their expected volatility. This measure is referred to as a
calculated value rather than as a fair-value-based measure. Under the second exception, nonpublic
entities are permitted to make an accounting policy election to measure all liability-classified awards at
their intrinsic value (instead of at their fair-value-based measure or calculated value) as of the end of
each reporting period until the awards are settled. See Section 4.13 for additional discussion of each
measurement exception.
4.1.1 Vesting Conditions
ASC 718-10
Forfeitability
30-11 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.
Performance or Service Conditions

30-12 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 718-20-55-4 through 55-40) and Example 1 (see paragraph 718-30-55-1) provide
illustrations of how compensation cost is recognized for awards with service and performance conditions.
30-13 The fair-value-based method described in paragraphs 718-10-30-6 and 718-10-30-10 through 30-14
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.
124

30-28 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.
SAB Topic 14.D.2, Certain Assumptions Used in Valuation Methods: Expected Term [Excerpt; Reproduced in
ASC 718-10-S99-1]
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
employees render the requisite service.67

67
125
An entity should consider all relevant terms and conditions of a share-based payment award in
determining an appropriate fair-value-based measure. Each of these terms and conditions may have
a direct or indirect effect on the fair-value-based measure of the award. A service or performance
condition that affects either the vesting or the exercisability of an award is considered a vesting
condition. Vesting conditions are not directly incorporated into an award’s fair-value-based measure.
Rather, they govern whether the award has been earned and therefore whether an entity records
compensation cost for it. However, a vesting condition can indirectly affect the fair-value-based measure.
Since the expected term of an option award cannot be shorter than the vesting period (because the
expected term should not incorporate prevesting forfeitures), a longer vesting period would typically
result in an increase in the expected term of an award. See Sections 3.4.1 and 3.4.2 for a discussion of
how service and performance conditions affect the recognition of compensation cost.
By contrast, a service or performance condition that affects a factor (e.g., exercise price, contractual
term, quantity, conversion ratio) other than vesting or exercisability of an award will be directly factored
into the award’s fair-value-based measure. See Section 4.6 for a discussion of how service and
performance conditions that affect factors other than vesting or exercisability of an award affect the
A market condition is not considered a vesting condition under ASC 718-10-30-27. Accordingly, it will be
directly factored into the fair-value-based measure of an award and will not be used to determine (other
than indirectly if a derived service period is required to be determined) whether compensation cost will
be recorded. ASC 718-10-30-14 states, in part, that the “effect of a market condition is reflected in the
grant-date fair value of an award.” See Section 3.5 for a discussion of how a market condition affects the
recognition of compensation cost and Section 4.5 for a discussion of how a market condition affects an
If an award is indexed to a factor other than a market, performance, or service condition, it contains
an “other” condition. Other conditions are factored into the fair-value-based measure of an award and
result in its classification as a liability. See Section 4.6.2 for discussion of other conditions.
4.1.2 Reload and Contingent Features

Reload Feature and Reload Option

A reload feature provides for automatic grants of additional options whenever a grantee exercises previously
granted options using the entity’s shares, rather than cash, to satisfy the exercise price. At the time of exercise
using shares, the grantee is automatically granted a new option, called a reload option, for the shares used to
exercise the previous option.
ASC 718-10
Reload and Contingent Features

30-23 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.
126
718-10-55-8), shall not be reflected in estimating the grant-date fair value of an equity instrument.
Fair Value Measurement Objectives and Application

Contingency Features That Affect the Option Pricing Model

55-47 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.
Some stock options include a “reload feature.” This feature entitles a grantee to automatic grants of
additional stock options whenever the grantee exercises previously granted stock options and pays the
exercise price in the entity’s shares rather than in cash. Typically, the grantee is granted a new stock
option, called a reload option, for each share surrendered to satisfy the exercise price of the previously
granted stock option. The exercise price of the reload option is usually set at the market price of the
shares on the date the reload option is granted. For stock options that include a reload feature, the
reload feature is not incorporated into the grant-date fair-value-based measure of the stock option but
is accounted for instead as a new award and calculated on the basis of its grant-date fair-value-based
measure.
Some awards also include contingent features that may require a grantee to return earned equity
instruments or gains realized from the sale of equity instruments in certain situations (either for no
consideration or for consideration that is less than the fair value of the equity instrument on the date of
transfer). Such contingent features are not reflected in the fair-value-based measurement of an equity
instrument, and they do not affect the recognition of compensation cost if they are triggered after the
equity instrument is earned. Therefore, a contingent feature has no day-one impact on the accounting
127
for an award; it is accounted for if and when the contingent event occurs. Examples of contingent
features, also referred to as clawback features, include provisions triggered upon terminations for
cause, noncompete and nonsolicitation violations, and material misstatements. Clawback provisions are
discussed further in Section 3.9.
4.2 Measurement Objective
ASC 718-10
Measurement Objective — Fair Value at Grant Date
30-6 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.

55-4 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 718-10-55-21 through 55-22, if applicable) at the grant date and is
not remeasured in subsequent periods under the fair-value-based method.
55-6 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.
128
55-9 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.
Fair-Value-Based Instruments in a Share-Based Transaction

55-10 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.
55-11 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.
55-12 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.
Valuation Techniques
55-13 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.
129
55-14 The fair value of any equity or liability instrument depends on its substantive characteristics. Paragraphs
718-10-55-21 through 55-22 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 718-10-55-15 through 55-20, to select a valuation technique that incorporates those
characteristics.
As indicated above, ASC 718-10-30-6 specifies that the measurement objective for share-based payment
arrangements is to estimate the fair-value-based measure, on the measurement date, “of the equity
[and liability] 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.” This estimate is based on the share price and other measurement assumptions (e.g.,
the option pricing model inputs as described in ASC 718-10-55-21 in estimating the fair-value-based
measure of stock options) on the measurement date.
In SAB Topic 14, the SEC provides the following general guidance on estimating the fair-value-based
measure of share-based payment arrangements:
SAB Topic 14, Share-Based Payment [Excerpt; Reproduced in ASC 718-10-S99-1]

The staff recognizes that there is a range of conduct that a reasonable issuer might use to make estimates
and valuations and otherwise implement FASB ASC Topic 718, and the interpretive guidance provided by this
SAB, particularly during the period of the Topic’s initial implementation. 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 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. Over time, as issuers
and accountants gain more experience in applying FASB ASC Topic 718 and the guidance provided in this SAB,
the staff anticipates that particular approaches may begin to emerge as best practices and that the range of
reasonable conduct, conclusions and methodologies will likely narrow.
SAB Topic 14.C, Valuation Methods [Excerpt; Reproduced in ASC 718-10-S99-1]

FASB ASC paragraph 718-10-30-6 (Compensation — Stock Compensation Topic) indicates that the
measurement objective for equity instruments awarded to employees is to estimate at the grant date the fair
value of the equity instruments the entity is obligated to issue when employees have rendered the requisite
service and satisfied any other conditions necessary to earn the right to benefit from the instruments. 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 with employees.22 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 718.23
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 employees who received the share options?
130
SEC Staff Accounting Bulletins (continued)
Interpretive Response: The staff understands that estimates of fair value of employee share options, while
derived from expected value calculations, cannot predict actual future events.24 The estimate of fair value
represents the measurement of the cost of the employee 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 date of the measurement (generally the grant date for equity awards). For example,
valuation techniques used in estimating the fair value of employee 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 instruments
value that marketplace participants would reasonably make, then subsequent future events that affect the
instruments 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 an employee share options 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.
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.25
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 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.

22

23
FASB ASC paragraph 718-10-55-15 states “The fair value of those instruments at a single point in time is not a forecast of
24
what the estimated fair value of those instruments may be in the future.”
See FASB ASC paragraphs 718-10-55-16 and 718-10-55-20.
25
131
As indicated in SAB Topic 14, fair-value-based estimates are not predictions of actual future events. As
long as an entity makes a good faith estimate in accordance with the principles in ASC 718, subsequent
changes to the fair-value-based measurement will not call into question the reasonableness of the
estimate. However, entities must consider the substantive terms of an award in a manner in which a
market participant would consider them. In addition, the SEC staff will not object to an entity’s valuation
technique provided that it meets all three of the following criteria in ASC 718-10-55-11:
• “It is applied in a manner consistent with the fair value measurement objective and the other
requirements of this Topic [ASC 718].”
• “It is based on established principles of financial economic theory and generally applied in that
field. . . . 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).”
• “It reflects all substantive characteristics of the instrument (except for those explicitly excluded
by this Topic [ASC 718], such as vesting conditions and reload features).”
For example, if an award contains a market condition, a Monte Carlo simulation is often used as a
valuation technique rather than a Black-Scholes-Merton model.
Further, as long as fair-value-based estimates are prepared by a person with the “requisite expertise,”
entities are not required to hire an outside third-party expert to assist in the valuation. For example, if a
Black-Scholes-Merton model is applied, a valuation expert may not be required for many types of stock
options.
4.3 Observable Market Price

To determine the fair-value-based measure of the underlying instrument in a share-based payment
arrangement, an entity must first consider whether there is an observable market price; that is, the price
that buyers are paying for an instrument (with the same or similar terms) in an active market, which is
the best evidence of fair value. An observable market price will generally only be available for shares of
public entities or for shares of nonpublic entities with recent transactions. For example, for grants of
restricted stock subject only to service or performance conditions, the market price of a public entity’s
common stock would be used as the fair-value-based measurement. However, for grants of stock
options, observable market prices would typically not exist (see Section 4.9.3 for additional information).
If an observable market price does not exist, an acceptable valuation technique must be used to
estimate the fair-value-based measure of the award.
See Section 4.12 for a discussion of the valuation of awards issued by nonpublic entities, and see
Section 4.9 for a discussion of option pricing models, which are valuation techniques used to estimate
the fair-value-based measure of options and similar instruments.
132
4.4 Measurement Date
For equity-classified awards, the measurement date is the grant date (i.e., the date on which the
measurement of the award is fixed). As discussed in Chapter 3, the service inception date may precede
the grant date for both employee and nonemployee awards. As a result, even though an entity may
begin to record compensation cost before the grant date, the fair-value-based measure of an equity-
classified award is not fixed until the grant date. In periods before the grant date, compensation cost is
remeasured on the basis of the award’s fair-value-based measure at the end of each reporting period
to the extent that service has been rendered in proportion to the total requisite service period. See
Section 3.6.4 for guidance on accounting for a share-based payment award when the service inception
date precedes the grant date.
For liability-classified awards, the ultimate measurement date is the settlement date. That is, unlike
equity-classified awards, liability-classified awards are remeasured at their fair-value-based measure
in each reporting period until settlement. The changes in the fair-value-based measure of the liability-
classified award at the end of each reporting period are recognized as compensation cost either
immediately or over the remaining vesting period (or both), depending on the employee’s requisite
service period or the nonemployee’s vesting period. See Chapter 7 for further discussion of the
accounting for liability-classified awards.
4.5 Market Conditions
ASC 718-10
Market Conditions
30-14 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.


As discussed in Section 4.1, a market condition is not considered a vesting condition. Unlike service and
performance conditions that affect vesting, the effect of market conditions is reflected in an award’s
fair-value-based measure. In addition, compensation cost is recognized for equity-classified awards
with market conditions, regardless of whether the market condition is achieved, as long as the good is
delivered or the service is rendered. See Section 3.5 for a discussion of how a market condition affects
the recognition of compensation cost.
133
For an entity to effectively incorporate a market condition into an award’s fair-value-based measure, the
valuation technique used must take into account all possible outcomes of the market condition. That is,
the valuation technique must permit the entity to estimate the value of “path-dependent options.” ASC
718-10-30-14 states, in part, that “[a]wards with market conditions, as defined in this Topic, are path-
dependent options.” Lattice models and Monte Carlo simulations are valuation techniques used to value
path dependent options. The Black-Scholes-Merton formula typically will not be appropriate when there
are market conditions.
The implementation guidance in ASC 718-20 provides the following examples of awards with market
conditions:
ASC 718-20
Example 5: Share Option With a Market Condition — Indexed Exercise Price

concepts about valuation in paragraphs 718-20-55-52 through 55-60 are equally applicable to nonemployee
awards with the same features as the awards in this Example (that is, awards with market conditions that affect
exercise prices). Therefore, the guidance in those paragraphs may serve as implementation guidance for similar
nonemployee awards.
transactions.
55-52 Entity T grants share options whose exercise price varies with an index of the share prices of a group of
entities in the same industry, that is, a market condition. Assume that on January 1, 20X5, Entity T grants 100
share options on its common stock with an initial exercise price of $30 to each of 1,000 employees. The share
options have a maximum term of 10 years. The exercise price of the share options increases or decreases on
December 31 of each year by the same percentage that the index has increased or decreased during the year.
For example, if the peer group index increases by 10 percent in 20X5, the exercise price of the share options
during 20X6 increases to $33 ($30 × 1.10). On January 1, 20X5, the peer group index is assumed to be 400. The
dividend yield on the index is assumed to be 1.25 percent.
55-53 Each indexed share option may be analyzed as a share option to exchange 0.0750 (30 ÷ 400) shares
of the peer group index for a share of Entity T stock — that is, to exchange one noncash asset for another
noncash asset. A share option to purchase stock for cash also can be thought of as a share option to exchange
one asset (cash in the amount of the exercise price) for another (the share of stock). The intrinsic value of a
cash share option equals the difference between the price of the stock upon exercise and the amount — the
price — of the cash exchanged for the stock. The intrinsic value of a share option to exchange 0.0750 shares
of the peer group index for a share of Entity T stock also equals the difference between the prices of the two
assets exchanged.
134
55-54 To illustrate the equivalence of an indexed share option and the share option above, assume that an
employee exercises the indexed share option when Entity T’s share price has increased 100 percent to $60
and the peer group index has increased 75 percent, from 400 to 700. The exercise price of the indexed share
option thus is $52.50 ($30 × 1.75).
Price of Entity T share $ 60.00
Less: Exercise price of share option 52.50
Intrinsic value of indexed share option $ 7.50
55-55 That is the same as the intrinsic value of a share option to exchange 0.0750 shares of the index for 1
share of Entity T stock.
Price of Entity T share $ 60.00
Less: Price of a share of the peer group index (.0750 × $700) 52.50
Intrinsic value at exchange $ 7.50
55-56 Option-pricing models can be extended to value a share option to exchange one asset for another.
The principal extension is that the volatility of a share option to exchange two noncash assets is based on
the relationship between the volatilities of the prices of the assets to be exchanged — their cross-volatility.
In a share option with an exercise price payable in cash, the amount of cash to be paid has zero volatility, so
only the volatility of the stock needs to be considered in estimating that option’s fair value. In contrast, the
fair value of a share option to exchange two noncash assets depends on possible movements in the prices
of both assets — in this Example, fair value depends on the cross-volatility of a share of the peer group index
and a share of Entity T stock. Historical cross-volatility can be computed directly based on measures of Entity
T’s share price in shares of the peer group index. For example, Entity T’s share price was 0.0750 shares at the
grant date and 0.0857 (60 ÷ 700) shares at the exercise date. Those share amounts then are used to compute
cross-volatility. Cross-volatility also can be computed indirectly based on the respective volatilities of Entity T
stock and the peer group index and the correlation between them. The expected cross-volatility between Entity
T stock and the peer group index is assumed to be 30 percent.
55-57 In a share option with an exercise price payable in cash, the assumed risk-free interest rate (discount
rate) represents the return on the cash that will not be paid until exercise. In this Example, an equivalent share
of the index, rather than cash, is what will not be paid until exercise. Therefore, the dividend yield on the peer
group index of 1.25 percent is used in place of the risk-free interest rate as an input to the option-pricing
model.
135
55-58 The initial exercise price for the indexed share option is the value of an equivalent share of the peer
group index, which is $30 (0.0750 × $400). The fair value of each share option granted is $7.55 based on the
following inputs.
Share price $ 30
Exercise price $ 30
Dividend yield 1.00%
Discount rate 1.25%
Volatility 30%
Contractual term 10 years
Suboptimal exercise factor 1.10
55-59 In this Example, the suboptimal exercise factor is 1.1. In Example 1 (see paragraph 718-20-55-4),
the suboptimal exercise factor is 2.0. See paragraph 718-20-55-8 for an explanation of the meaning of a
suboptimal exercise factor of 2.0.
55-60 The indexed share options have a three-year explicit service period. The market condition affects the
grant-date fair value of the award and its exercisability; however, vesting is based solely on the explicit service
period of three years. The at-the-money nature of the award makes the derived service period irrelevant in
determining the requisite service period in this Example; therefore, the requisite service period of the award
is three years based on the explicit service period. The accrual of compensation cost would be based on the
number of options for which the requisite service is rendered or is expected to be rendered depending on an
entity’s accounting policy in accordance with paragraph 718-10-35-3 (which is not addressed in this Example).
That cost would be recognized over the requisite service period as shown in Example 1 (see paragraph
718-20-55-4).
Example 6: Share Unit With Performance and Market Conditions

55-61 This Example illustrates the guidance in paragraphs 718-10-25-20 through 25-21, 718-10-30-27, and
718-10-35-4.
55-61A This Example (see paragraphs 718-20-55-62 through 55-67) describes employee awards. However, the
principles on how to account for the various aspects of employee awards, except for the compensation cost
attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, both of the
following are equally applicable to nonemployee awards with the same features as the awards in this Example
(that is, awards with a specified time period for vesting and the recognition of compensation cost based on the
achievement of particular performance conditions):
a. The performance conditions in paragraph 718-20-55-62
b. Concepts about valuation, compensation cost reversal, and total compensation cost that should be
recognized (that is, the consideration of whether it is probable that performance conditions will be
achieved) in paragraphs 718-20-55-63 and 718-20-55-65 through 55-67.
Therefore, the guidance in those paragraphs may serve as implementation guidance for similar nonemployee
awards.
transactions.
136
55-62 Entity T grants 100,000 share units to each of 10 vice presidents (1 million share units in total) on January
1, 20X5. Each share unit has a contractual term of three years and a vesting condition based on performance.
The performance condition is different for each vice president and is based on specified goals to be achieved
over three years (an explicit three-year service period). If the specified goals are not achieved at the end of
three years, the share units will not vest. Each share unit is convertible into shares of Entity T at contractual
maturity as follows:
a. If Entity T’s share price has appreciated by a percentage that exceeds the percentage appreciation of
the S&P 500 index by at least 10 percent (that is, the relative percentage increase is at least 10 percent),
each share unit converts into 3 shares of Entity T stock.
b. If the relative percentage increase is less than 10 percent but greater than zero percent, each share unit
converts into 2 shares of Entity T stock.
c. If the relative percentage increase is less than or equal to zero percent, each share unit converts into 1
share of Entity T stock.
d. If Entity T’s share price has depreciated, each share unit converts into zero shares of Entity T stock.
55-63 Appreciation or depreciation for Entity T’s share price and the S&P 500 index is measured from the grant
date.
55-64 This market condition affects the ability to retain the award because the conversion ratio could be zero;
however, vesting is based solely on the explicit service period of three years, which is equal to the contractual
maturity of the award. That set of circumstances makes the derived service period irrelevant in determining the
requisite service period; therefore, the requisite service period of the award is three years based on the explicit
service period.
55-65 The share units’ conversion feature is based on a variable target stock price (that is, the target stock
price varies based on the S&P 500 index); hence, it is a market condition. That market condition affects the
fair value of the share units that vest. Each vice president’s share units vest only if the individual’s performance
condition is achieved; consequently, this award is accounted for as an award with a performance condition
(see paragraphs 718-10-55-60 through 55-63). This Example assumes that all share units become fully vested;
however, if the share units do not vest because the performance conditions are not achieved, Entity T would
reverse any previously recognized compensation cost associated with the nonvested share units.
55-66 The grant-date fair value of each share unit is assumed for purposes of this Example to be $36. Certain
option-pricing models, including Monte Carlo simulation techniques, have been adapted to value path-
dependent options and other complex instruments. In this case, the entity concludes that a Monte Carlo
simulation technique provides a reasonable estimate of fair value. Each simulation represents a potential
outcome, which determines whether a share unit would convert into three, two, one, or zero shares of stock.
For simplicity, this Example assumes that no forfeitures will occur during the vesting period. The grant-date
fair value of the award is $36 million (1 million × $36); management of Entity T expects that all share units will
vest because the performance conditions are probable of achievement. Entity T recognizes compensation
cost of $12 million ($36 million ÷ 3) in each year of the 3-year service period; the following journal entries are
recognized by Entity T in 20X5, 20X6, and 20X7.


related to compensation cost ($12,000,000 × .35 = $4,200,000).
137
55-67 Upon contractual maturity of the share units, four outcomes are possible; however, because all possible
outcomes of the market condition were incorporated into the share units’ grant-date fair value, no other entry
related to compensation cost is necessary to account for the actual outcome of the market condition. However,
if the share units’ conversion ratio was based on achieving a performance condition rather than on satisfying a
market condition, compensation cost would be adjusted according to the actual outcome of the performance
condition (see Example 4 [paragraph 718-20-55-47]).
4.6 Conditions That Affect Factors Other Than Vesting or Exercisability

ASC 718-10
Market, Performance, and Service Conditions That Affect Factors Other Than Vesting or Exercisability
30-15 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 718-10-55-64
through 55-66 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.
Market, Performance, and Service Conditions That Affect Factors Other Than Vesting and Exercisability
55-64 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.
55-65 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.
138
As discussed in Section 4.1.1, service and performance conditions typically affect either the vesting or
the exercisability of a share-based payment award, and such vesting conditions are not directly factored
into the fair-value-based measure of an award under ASC 718. However, if service or performance
conditions affect factors other than vesting or exercisability (e.g., exercise price, contractual term,
quantity, or conversion ratio), the grant-date fair-value-based measure should be calculated for each
possible outcome. As discussed in Section 3.4.2, initial accruals of compensation cost should be based
on the probable outcome, and the final measure of compensation cost should be adjusted to reflect the
grant-date fair-value-based measure of the outcome that is actually achieved. See the next section for
examples that illustrate the application of this guidance.
4.6.1 Market, Performance, and Service Conditions

The example below illustrates the accounting for an award that contains a performance condition that
affects the number of options that will vest.
ASC 718-20
Example 2: Share Option Award Under Which the Number of Options to Be Earned Varies
attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, all of the
(that is, the number of options earned varies on the basis of the achievement of particular performance
conditions):
a. Certain valuation assumptions in paragraph 718-20-55-36
b. Total compensation cost considerations provided in paragraphs 718-20-55-37 through 55-39 (that is, an
entity must consider if it is probable that specific performance conditions will be achieved for an award
with a specified time period for vesting and performance conditions)
c. Forfeiture adjustments in paragraph 718-20-55-40.
awards.
transactions.
139
55-36 This Example shows the computation of compensation cost if Entity T grants an award of share options
with multiple performance conditions. Under the award, employees vest in differing numbers of options
depending on the amount by which the market share of one of Entity T’s products increases over a three-year
period (the share options cannot vest before the end of the three-year period). The three-year explicit service
period represents the requisite service period. On January 1, 20X5, Entity T grants to each of 1,000 employees
an award of up to 300 10-year-term share options on its common stock. If market share increases by at least
5 percentage points by December 31, 20X7, each employee vests in at least 100 share options at that date.
If market share increases by at least 10 percentage points, another 100 share options vest, for a total of 200.
If market share increases by more than 20 percentage points, each employee vests in all 300 share options.
Entity T’s share price on January 1, 20X5, is $30 and other assumptions are the same as in Example 1 (see
paragraph 718-20-55-4). The grant-date fair value per share option is $14.69. While the vesting conditions in
this Example and in Example 1 (see paragraph 718-20-55-4) are different, the equity instruments being valued
have the same estimate of grant-date fair value. That is a consequence of the modified grant-date method,
which accounts for the effects of vesting requirements or other restrictions that apply during the vesting period
by recognizing compensation cost only for the instruments that actually vest. (This discussion does not refer
to awards with market conditions that affect exercisability or the ability to retain the award as described in
paragraphs 718-10-55-60 through 55-63.)
55-37 The compensation cost of the award depends on the estimated number of options that will vest. Entity
T must determine whether it is probable that any performance condition will be achieved, that is, whether
the growth in market share over the 3-year period will be at least 5 percent. Accruals of compensation cost
are initially based on the probable outcome of the performance conditions — in this case, different levels
of market share growth over the three-year vesting period — and adjusted for subsequent changes in the
estimated or actual outcome. If Entity T determines that no performance condition is probable of achievement
(that is, market share growth is expected to be less than 5 percentage points), then no compensation cost
is recognized; however, Entity T is required to reassess at each reporting date whether achievement of any
performance condition is probable and would begin recognizing compensation cost if and when achievement
of the performance condition becomes probable.
55-38 Paragraph 718-10-25-20 requires accruals of cost to be based on the probable outcome of performance
conditions. Accordingly, this Topic prohibits Entity T from basing accruals of compensation cost on an amount
that is not a possible outcome (and thus cannot be the probable outcome). For instance, if Entity T estimates
that there is a 90 percent, 30 percent, and 10 percent likelihood that market share growth will be at least 5
percentage points, at least 10 percentage points, and greater than 20 percentage points, respectively, it would
not try to determine a weighted average of the possible outcomes because that number of shares is not a
possible outcome under the arrangement.
55-39 The following table shows the compensation cost that would be recognized in 20X5, 20X6, and 20X7 if
Entity T estimates at the grant date that it is probable that market share will increase at least 5 but less than 10
percentage points (that is, each employee would receive 100 share options). That estimate remains unchanged
until the end of 20X7, when Entity T’s market share has increased over the 3-year period by more than 10
percentage points. Thus, each employee vests in 200 share options.
140
55-40 As in Example 1, Case A (see paragraph 718-20-55-10), Entity T experiences actual forfeiture rates of
5 percent in 20X5, and in 20X6 changes its estimate of forfeitures for the entire award from 3 percent to 6
percent per year. In 20X6, cumulative compensation cost is adjusted to reflect the higher forfeiture rate. By the
end of 20X7, a 6 percent forfeiture rate has been experienced, and no further adjustments for forfeitures are
necessary. Through 20X5, Entity T estimates that 913 employees (1,000 × .973) will remain in service until the
vesting date. At the end of 20X6, the number of employees estimated to remain in service is adjusted for the
higher forfeiture rate, and the number of employees estimated to remain in service is 831 (1,000 × .943). The
compensation cost of the award is initially estimated based on the number of options expected to vest, which
in turn is based on the expected level of performance and the fair value of each option. That amount would
be adjusted as needed for changes in the estimated and actual forfeiture rates and for differences between
estimated and actual market share growth. The amount of compensation cost recognized (or attributed) when
achievement of a performance condition is probable depends on the relative satisfaction of the performance
condition based on performance to date. Entity T determines that recognizing compensation cost ratably over
the three-year vesting period is appropriate with one-third of the value of the award recognized each year.
Share Option With Performance Condition — Number of Share Options Varies
Cumulative
Year Total Value of Award Pretax Cost for Year Pretax Cost
20X5 $1,341,197 ($14.69 × 100 × 913) $447,066 ($1,341,197 ÷ 3) $ 447,066
20X6 $1,220,739 ($14.69 × 100 × 831) $366,760 [($1,220,739 × 2/3) – $447,066] $ 813,826
20X7 $2,441,478 ($14.69 × 200 × 831) $1,627,652 ($2,441,478 – $813,826) $ 2,441,478
The examples below illustrate the accounting for an award with either a performance condition
(Example 3) or a market condition (Example 7) that affects the exercise price of stock options.
ASC 718-20
Example 3: Share Option Award Under Which the Exercise Price Varies
attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, both of the
(that is, an immediately vested and exercisable award with an exercise price that varies on the basis of the
achievement of particular performance conditions):
a. Certain valuation assumptions in paragraphs 718-20-55-42 through 55-43
b. The total compensation cost considerations provided in paragraphs 718-20-55-44 through 55-46 (that
is, an entity must consider if it is probable that specific performance conditions will be achieved).
awards.
transactions.
141
55-42 This Example shows the computation of compensation cost if Entity T grants a share option award with
a performance condition under which the exercise price, rather than the number of shares, varies depending
on the level of performance achieved. On January 1, 20X5, Entity T grants to its chief executive officer 10-year
share options on 10,000 shares of its common stock, which are immediately vested and exercisable (an
explicit service period of zero). The share price at the grant date is $30, and the initial exercise price also is
$30. However, that price decreases to $15 if the market share for Entity T’s products increases by at least
10 percentage points by December 31, 20X6, and provided that the chief executive officer continues to be
employed by Entity T and has not previously exercised the options (an explicit service period of 2 years, which
also is the requisite service period).
55-43 Entity T estimates at the grant date the expected level of market share growth, the exercise price of the
options, and the expected term of the options. Other assumptions, including the risk-free interest rate and
the service period over which the cost is attributed, are consistent with those estimates. Entity T estimates at
the grant date that its market share growth will be at least 10 percentage points over the 2-year performance
period, which means that the expected exercise price of the share options is $15, resulting in a fair value of
$19.99 per option. Option value is determined using the same assumptions noted in paragraph 718-20-55-7
except the exercise price is $15 and the award is not exercisable at $15 per option for 2 years.
55-44 Total compensation cost to be recognized if the performance condition is satisfied would be $199,900
(10,000 × $19.99). Paragraph 718-10-30-15 requires that the fair value of both awards with service conditions
and awards with performance conditions be estimated as of the date of grant. Paragraph 718-10-35-3 also
requires recognition of cost for the number of instruments for which the requisite service is provided. For this
performance award, Entity T also selects the expected assumptions at the grant date if the performance goal is
not met. If market share growth is not at least 10 percentage points over the 2-year period, Entity T estimates
a fair value of $13.08 per option. Option value is determined using the same assumptions noted in paragraph
718-20-55-7 except the award is immediately vested.
55-45 Total compensation cost to be recognized if the performance goal is not met would be $130,800 (10,000
× $13.08). Because Entity T estimates that the performance condition would be satisfied, it would recognize
compensation cost of $130,800 on the date of grant related to the fair value of the fully vested award and
recognize compensation cost of $69,100 ($199,900 – $130,800) over the 2-year requisite service period related
to the condition. Because of the nature of the performance condition, the award has multiple requisite service
periods that affect the manner in which compensation cost is attributed. Paragraphs 718-10-55-67 through
55-79 provide guidance on estimating the requisite service period.
55-46 During the two-year requisite service period, adjustments to reflect any change in estimate about
satisfaction of the performance condition should be made, and, thus, aggregate cost recognized by the end of
that period reflects whether the performance goal was met.
Example 7: Share Option With Exercise Price That Increases by a Fixed Amount or Fixed Percentage
attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, the concepts
about valuation in paragraphs 718-20-55-69 through 55-70 are equally applicable to nonemployee awards
with the same features as the awards in this Example (that is, awards with exercise prices that increase by a
fixed amount or fixed percentage). Therefore, the guidance in those paragraphs may serve as implementation
guidance for similar nonemployee awards.
142
transactions.
55-69 Some entities grant share options with exercise prices that increase by a fixed amount or a constant
percentage periodically. For example, the exercise price of the share options in Example 1 (see paragraph
718-20-55-4) might increase by a fixed amount of $2.50 per year. Lattice models and other valuation
techniques can be adapted to accommodate exercise prices that change over time by a fixed amount. Such an
arrangement has a market condition and may have a derived service period.
55-70 Share options with exercise prices that increase by a constant percentage also can be valued using an
option-pricing model that accommodates changes in exercise prices. Alternatively, those share options can be
valued by deducting from the discount rate the annual percentage increase in the exercise price. That method
works because a decrease in the risk-free interest rate and an increase in the exercise price have a similar
effect — both reduce the share option value. For example, the exercise price of the share options in Example
1 (see paragraph 718-20-55-4) might increase at the rate of 1 percent annually. For that example, Entity T’s
share options would be valued based on a risk-free interest rate less 1 percent. Holding all other assumptions
constant from that Example, the value of each share option granted by Entity T would be $14.34.
The example below illustrates the accounting for an award with performance conditions that affect the
vesting and transferability of stock options.
ASC 718-20
Example 4: Share Option Award With Other Performance Conditions

concepts about valuation, expected term, and total compensation cost that should be recognized (that is, the
consideration of whether it is probable that performance conditions will be achieved) in paragraphs 718-20-
55-48 through 55-50 are equally applicable to nonemployee awards with the same features as the awards in
this Example (that is, awards with performance conditions that affect inputs to an award’s fair value). Therefore,
transactions.
55-48 While performance conditions usually affect vesting conditions, they may affect exercise price,
contractual term, quantity, or other factors that affect an award’s fair value before, at the time of, or after
vesting. This Topic requires that all performance conditions be accounted for similarly. A potential grant-date
fair value is estimated for each of the possible outcomes that are reasonably determinable at the grant date
and associated with the performance condition(s) of the award (as demonstrated in Example 3 [see paragraph
718-20-55-41)]. Compensation cost ultimately recognized is equal to the grant-date fair value of the award that
coincides with the actual outcome of the performance condition(s).
143
ASC 718-20
55-49 To illustrate the notion described in the preceding paragraph and attribution of compensation cost if
performance conditions have different service periods, assume Entity C grants 10,000 at-the-money share
options on its common stock to an employee. The options have a 10-year contractual term. The share options
vest upon successful completion of phase-two clinical trials to satisfy regulatory testing requirements related to
a developmental drug therapy. Phase-two clinical trials are scheduled to be completed (and regulatory approval
of that phase obtained) in approximately 18 months; hence, the implicit service period is approximately 18
months. Further, the share options will become fully transferable upon regulatory approval of the drug therapy
(which is scheduled to occur in approximately four years). The implicit service period for that performance
condition is approximately 30 months (beginning once phase-two clinical trials are successfully completed).
Based on the nature of the performance conditions, the award has multiple requisite service periods (one
pertaining to each performance condition) that affect the pattern in which compensation cost is attributed.
Paragraphs 718-10-55-67 through 55-79 and 718-10-55-86 through 55-88 provide guidance on estimating the
requisite service period of an award. The determination of whether compensation cost should be recognized
depends on Entity C’s assessment of whether the performance conditions are probable of achievement. Entity
C expects that all performance conditions will be achieved. That assessment is based on the relevant facts and
circumstances, including Entity C’s historical success rate of bringing developmental drug therapies to market.
55-50 At the grant date, Entity C estimates that the potential fair value of each share option under the 2
possible outcomes is $10 (Outcome 1, in which the share options vest and do not become transferable) and
$16 (Outcome 2, in which the share options vest and do become transferable). The difference in estimated fair
values of each outcome is due to the change in estimate of the expected term of the share option. Outcome 1
uses an expected term in estimating fair value that is less than the expected term used for Outcome 2, which
is equal to the award’s 10-year contractual term. If a share option is transferable, its expected term is equal to
its contractual term (see paragraph 718-10-55-29). If Outcome 1 is considered probable of occurring, Entity C
would recognize $100,000 (10,000 × $10) of compensation cost ratably over the 18-month requisite service
period related to the successful completion of phase-two clinical trials. If Outcome 2 is considered probable
of occurring, then Entity C would recognize an additional $60,000 [10,000 × ($16 – $10)] of compensation cost
ratably over the 30-month requisite service period (which begins after phase-two clinical trials are successfully
completed) related to regulatory approval of the drug therapy. Because Entity C believes that Outcome 2 is
probable, it recognizes compensation cost in the pattern described. However, if circumstances change and it is
determined at the end of Year 3 that the regulatory approval of the developmental drug therapy is likely to be
obtained in six years rather than four, the requisite service period for Outcome 2 is revised, and the remaining
unrecognized compensation cost would be recognized prospectively through Year 6. On the other hand, if it
becomes probable that Outcome 2 will not occur, compensation cost recognized for Outcome 2, if any, would
be reversed.
The example below illustrates the accounting for an award with a performance condition that affects the
quantity of restricted stock awards earned.
Example 4-1
On January 1, 20X6, Entity A grants 100,000 restricted stock awards to its employees. The restricted stock
awards have a grant-date fair-value-based measure of $30 per share and vest at the end of the third year of
service. The number of restricted stock awards that vest at the end of the three-year service period is based on
the target EBITDA growth rate (performance condition) as indicated in the following table:
EBITDA Growth Rate Payout
Minimum 6% 50%
Target 8% 100%
Maximum 10% 150%
144
Compensation cost for the awards is based on the probable outcome of the performance condition. If, on the
grant date, the probable outcome is that the EBITDA growth rate target of 8 percent will be met, initial accruals
of compensation cost should reflect vesting of 100,000 restricted stock awards. Accruals of compensation cost
should be adjusted for subsequent changes in the estimated or actual outcome. For example, if the actual
EBITDA growth rate at the end of the three-year period is 6 percent, or it becomes probable that the EBITDA
growth rate will be 6 percent, the cumulative compensation cost recognized should be adjusted to reflect
vesting of 50,000 restricted stock awards (100,000 restricted stock awards × 50 percent payout).
The journal entries below illustrate the accounting for the awards.
Journal Entry: December 31, 20X6
Compensation cost 1,000,000

APIC 1,000,000
To record compensation cost for the year ended December 31,
20X6, on the basis of the probable achievement of the target
EBITDA growth rate (100,000 restricted stock awards × $30
grant-date fair-value-based measure × 100 percent payout × 1/3 of
services rendered).
Compensation cost 1,000,000

APIC 1,000,000
20X7, on the basis of the probable achievement of the target
EBITDA growth rate [(100,000 restricted stock awards × $30
grant-date fair-value-based measure × 100 percent payout × 2/3
of services rendered) – $1,000,000 compensation cost previously
recognized].
As of December 31, 20X8, the actual EBITDA growth rate is 6 percent, resulting in a 50 percent payout.
APIC 500,000
To adjust compensation cost for the year ended December 31, 20X8,
on the basis of the actual achievement of the minimum EBITDA
growth rate [(100,000 restricted stock awards × $30 grant-date
fair-value-based measure × 50 percent payout × 3/3 of services
rendered) – $2,000,000 compensation cost previously recognized].
145
4.6.2 Other Conditions
An entity must carefully evaluate the terms and conditions of an award. If the entity determines that
the award is indexed to a factor other than a market, performance, or service condition (i.e., an “other”
condition), the award is classified as a share-based liability under ASC 718-10-25-13 (unless certain
exceptions apply). Such other condition should also be reflected in the estimate of the award’s fair-value-
based measure. For example, an entity may grant a restricted stock award that indexes the quantity
of shares that will vest to oil price changes. Even if the entity is in the oil and gas industry, the award is
classified as a liability. Accordingly, the fair-value-based measure of the award should be remeasured at
the end of each reporting period until settlement and should reflect changes in the market price of oil.
4.7 Nonvested Shares
Nonvested Shares
Shares that an entity has not yet issued because the agreed-upon consideration, such as the delivery
of specified goods or services and any other conditions necessary to earn the right to benefit from the
instruments, has not yet been satisfied. Nonvested shares cannot be sold. The restriction on sale of nonvested
shares is due to the forfeitability of the shares if specified events occur (or do not occur).
ASC 718-10
Nonvested or Restricted Shares

30-17 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.
As discussed in Section 3.3, a nonvested share, commonly known as restricted stock, is an award that
a grantee earns once the grantee has provided the good or service required under the terms of the
share-based payment arrangement. Further, as discussed throughout this Roadmap, the measurement
basis under ASC 718 is a fair-value-based measurement, which excludes the effects of service and
performance conditions that are vesting conditions. Therefore, restricted stock (with only service and
performance conditions) should generally be measured at the fair value of the entity’s common stock
as if the restricted stock were vested and issued on the grant date (an entity may need to adjust the
fair value for dividends, as discussed below). It would not be appropriate for the fair value of the entity’s
common stock to be discounted to reflect that the shares being valued are not vested.
While service and performance vesting conditions do not affect the fair-value-based measure of
restricted stock, the initial measurement of restricted stock could be affected by factors such as a
market condition, as discussed in ASC 718-10-30-14; a postvesting restriction, as discussed in ASC
718-10-30-10; or whether the grantee is entitled to dividends. As indicated in paragraph B93 of FASB
Statement 123(R), if a grantee holding a restricted stock award is not entitled to receive dividends (i.e.,
the grantee does not have the right of a normal shareholder), the fair-value-based measure of the award
would be lower than the fair value of a normal equity share if the entity is expected to pay dividends.
An entity should estimate the fair-value-based measure of restricted stock that does not entitle the
grantee to dividends during the service (vesting) period by reducing the fair value of its common stock
by the present value of expected dividends to be paid before the end of the service (vesting) period. The
present value of the expected dividends should be calculated by using an appropriate risk-free interest
rate as the discount rate. See Section 4.9.2.4 for a discussion of how dividends paid on grantee stock
options during the expected term affect the valuation of such awards, and see Section 12.4.3 for a
discussion of how dividend-paying restricted stock awards affect the computation of EPS.
146
4.8 Restricted Shares
Restricted Share
A share for which sale is contractually or governmentally prohibited for a specified period of time. Most grants
of shares to grantees are better termed nonvested shares because the limitation on sale stems solely from
the forfeitability of the shares before grantees have satisfied the service, performance, or other condition(s)
necessary to earn the rights to the shares. Restricted shares issued for consideration other than for goods or
services, on the other hand, are fully paid for immediately. For those shares, there is no period analogous to
an employee’s requisite service period or a nonemployee’s vesting period during which the issuer is unilaterally
obligated to issue shares when the purchaser pays for those shares, but the purchaser is not obligated to
buy the shares. The term restricted shares refers only to fully vested and outstanding shares whose sale is
contractually or governmentally prohibited for a specified period of time. Vested equity instruments that are
transferable to a grantee’s immediate family members or to a trust that benefits only those family members
are restricted if the transferred instruments retain the same prohibition on sale to third parties. See Nonvested
Shares.
ASC 718-10
Vesting Versus Nontransferability

30-10 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).
30-10A 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.
30-10B 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.
Nonvested or Restricted Shares

30-18 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.
30-19 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.
147

A restricted share is a fully vested and outstanding share whose sale is prohibited for a specified period.
For example, as described in Section 3.3, a grantee may be granted a fully vested share but may be
restricted from selling it for a two-year period. If the grantee ceases delivering goods or rendering
services to the entity before the end of the two-year period, the grantee retains the share. However,
the grantee’s ability to sell the share remains contingent on the lapse of the two-year period. When
determining a share-based payment award’s fair-value-based measure, an entity should generally
consider restrictions that are in effect after a grantee has vested in the award, such as the inability to
transfer or sell vested shares for a specified period, including any discounts relative to the fair value of
the shares without a postvesting restriction. This discount is often referred to as a discount for lack of
marketability (DLOM) or discount for illiquidity.
Entities must be able to provide objective and verifiable evidence supporting the amount of the
discount. In determining an appropriate discount, entities should consider the following remarks by
Barry Kanczuker, then associate chief accountant in the SEC’s Office of the Chief Accountant, at the 2015
AICPA Conference on Current SEC and PCAOB Developments:
I would now like to turn to an observation regarding the impact of post-vesting restrictions on the
measurement of share-based awards. The measurement of share-based awards impacts compensation
expense. Post-vesting restrictions, such as transfer or sale restrictions, are a common feature of many share-
based payment arrangements.
ASC 718 provides guidance on the accounting for share-based awards when the sale of the underlying shares
is prohibited for a period of time subsequent to the awards vesting date. The post-vesting restrictions should
be considered when estimating the grant-date fair value of the award [ASC 718-10-30-10]. I would expect that
a post-vesting restriction may result in a discount relative to the market value of common stock to reflect that
the market shares can be freely traded while restricted shares cannot. The assumptions used in determining
the value of the share-based award should be attributes that a market participant would consider related to the
underlying award, rather than an attribute related to the individual holding the award.
Some market participants have indicated that post-vesting holding restrictions on share-based payment
awards can result in significantly lower stock compensation expense. While post-vesting restrictions should
be considered in estimating the fair value of share-based payments [ASC 718-10-30-10], when evaluating the
appropriateness of measurement in this area, we continue to look to the guidance in ASC 718-10-55-5, which
states that “. . . if shares are traded in an active market, post-vesting restrictions may have little, if any, effect on
the amount at which the shares being valued would be exchanged”. With that being said, I would encourage
you to consult with the Staff if you believe that you have a fact pattern in which a post-vesting restriction results
in a significant discount being applied to the grant-date fair value of a share-based award. [Footnotes omitted]
148
In addition, entities should consider remarks by Sandie Kim, then professional accounting fellow in
the SEC’s Office of the Chief Accountant, at the 2007 AICPA Conference on Current SEC and PCAOB
Developments:
Statement 123(R) establishes fair value as the measurement objective in accounting for share-based payment
arrangements. While the actual measurement of share-based payment arrangements is not necessarily at fair
value and Statement 157 does not apply to such arrangements, Statement 123(R) nonetheless states that the
valuation and assumptions used should be consistent with the fair value measurement objective.
One analysis that may sometimes be difficult in valuing any security, not just those issued in share-based
payment arrangements, is determining which assumptions should be incorporated in the valuation because
they are attributes a market participant would consider (it is an attribute of the security), versus an attribute a
specific holder of the security would consider. For example, one common term we see in share-based payment
arrangements is a restriction that prohibits the transfer or sale of securities. If the security contains such a
restriction that continues after the requisite service period, that post-vesting restriction may be factored as a
reduction in the value of the security. As a reminder, the staff has previously communicated that the discount
calculated should be specific to the security, and not derived based on general rules of thumb.
On the other hand, we have also seen instances in which assumptions related to a specific holder attribute
were incorporated in the valuation of share-based payments. While the determination of which assumptions
to incorporate is judgmental, we believe that it would be difficult to substantiate that assumptions that reflect
an attribute of a specific holder versus a market participant would be appropriate. Statement 123(R) specifies
that the assumptions should reflect information available to form the basis for an amount at which the
instrument being valued would be exchanged, and that the assumptions used should not represent the biases
of a particular party. For example, we have heard arguments that a significant discount should be taken on
certain share-based payment awards because the securities were issued to a group of executives that were
subject to higher taxes than other employees. The staff does not believe this assumption is consistent with a
fair value measurement objective. As an additional observation, Statement 157 also refers to assumptions that
are incorporated in the fair value of a security because they are specific to the security (that is, attributes of the
security) and would, therefore, transfer to market participants. [Footnotes omitted]
There are several valuation techniques used to determine a DLOM, as further described in Section
4.12.1.
4.8.1 Options on Restricted Shares

If an entity grants options to acquire restricted shares (as defined in ASC 718), it should take into
account the effect of the postvesting restriction by using the restricted share value as an input in the
option pricing model. That is, the discount for the postvesting restriction should not be applied to the
output of the option pricing model.
For example, assume that a public entity issues an option with a four-year service (vesting) condition
and a postvesting restriction that prohibits the grantee from selling the shares obtained upon exercising
the option for another two years. If the entity estimates the fair-value-based measure of the option by
using a Black-Scholes-Merton formula, the input used for the current market price of the underlying
share generally will not be the quoted market price of the entity’s common stock since the underlying
share contains a postvesting restriction. Rather, the entity should generally use the fair value of a similar
restricted share as the input for the current market price (i.e., the fair value of a share containing similar
restrictions on transferability for a period of two years). The fair value of a restricted share typically
should be lower than the fair value of a similar share without any restrictions. Therefore, using the fair
value of a restricted share in the Black-Scholes-Merton formula will result in an estimated fair-value-
based measure of the option that is lower than that of an option without any postvesting restrictions on
the underlying share (if all other inputs remain the same).
149
A restriction on the ability to sell or transfer the option itself is different from a restriction on the
underlying share. If the option (as opposed to the underlying share) is nontransferable, which is typically
the case for employee stock options, the expected-term assumption is adjusted to reflect the restriction
rather than the input associated with the current market price of the underlying share. This restriction
generally leads to the early exercise of the option (before the end of the contractual term), and since a
discount is factored into the expected-term assumption, no additional discount should be applied to the
estimated fair-value-based measure derived from the option-pricing model. See Section 4.9.2.2.
4.8.2 Limited Population of Transferees

In certain cases, the terms of a share-based payment arrangement may permit the transfer of shares
only to a limited population, such as in an offering under Rule 144A of the Securities Act of 1933. A
limited population of transferees is not a prohibition on the sale of the instrument and therefore is
not considered a restriction under ASC 718. As described in Section 4.7, the fair-value-based measure
of restricted stock (i.e., nonvested shares) is calculated at the fair value of the entity’s common stock
as if the restricted stock were vested and issued on the grant date. An entity should not discount that
value solely because the entity’s common stock could be transferred to only a limited population of
transferees.
4.9 Option Pricing Models

Closed-Form Model
A valuation model that uses an equation to produce an estimated fair value. The Black-Scholes-Merton formula
is a closed-form model. In the context of option valuation, both closed-form models and lattice models are
based on risk-neutral valuation and a contingent claims framework. The payoff of a contingent claim, and thus
its value, depends on the value(s) of one or more other assets. The contingent claims framework is a valuation
methodology that explicitly recognizes that dependency and values the contingent claim as a function of
the value of the underlying asset(s). One application of that methodology is risk-neutral valuation in which
the contingent claim can be replicated by a combination of the underlying asset and a risk-free bond. If that
replication is possible, the value of the contingent claim can be determined without estimating the expected
returns on the underlying asset. The Black-Scholes-Merton formula is a special case of that replication.
Lattice Model
A model that produces an estimated fair value based on the assumed changes in prices of a financial
instrument over successive periods of time. The binomial model is an example of a lattice model. In each
time period, the model assumes that at least two price movements are possible. The lattice represents
the evolution of the value of either a financial instrument or a market variable for the purpose of valuing a
financial instrument. In this context, a lattice model is based on risk-neutral valuation and a contingent claims
framework. See Closed-Form Model for an explanation of the terms risk-neutral valuation and contingent
claims framework.
Intrinsic Value
The amount by which the fair value of the underlying stock exceeds the exercise price of an option. For
example, an option with an exercise price of $20 on a stock whose current market price is $25 has an intrinsic
value of $5. (A nonvested share may be described as an option on that share with an exercise price of zero.
Thus, the fair value of a share is the same as the intrinsic value of such an option on that share.)
Time Value
The portion of the fair value of an option that exceeds its intrinsic value. For example, a call option with an
exercise price of $20 on a stock whose current market price is $25 has intrinsic value of $5. If the fair value of
that option is $7, the time value of the option is $2 ($7 – $5).
150
ASC 718-10
30-7 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).
30-8 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.
30-9 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 718-10-55-4
through 55-47 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 718-10-55-21 through 55-22.
Valuation Techniques
55-15 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.
55-16 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
718-10-55-21 through 55-50, both lattice models and closed-form models can be adjusted to account for
the substantive characteristics of share options and similar instruments granted in share-based payment
transactions.
55-17 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 718-10-55-18 through 55-20 discuss certain factors that an entity should consider in
selecting a valuation technique or model for its share options or similar instruments.
151
55-18 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.
55-19 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.
ASC 718 describes fair value, in a fair-value-based measurement, as the amount at which market
participants would be willing to conduct transactions. In situations in which there is an absence of an
observable market price, which is generally the case for options and similar instruments granted to an
employee or nonemployee, an entity should use a valuation technique to estimate the fair-value-based
measure. Currently, the Black-Scholes-Merton (closed-form) and binomial (lattice or open-form) models
are the most commonly used valuation techniques for options and similar instruments. While ASC 718
does not prescribe a particular valuation technique, it should (1) be applied in a manner consistent with
the fair-value-based measurement objective and the other requirements in ASC 718, (2) be based on
established principles of financial theory (and generally applied in the valuation field), and (3) reflect all
substantive characteristics of an award.
An example of a closed-form model that is commonly used to value options and similar instruments is
the Black-Scholes-Merton formula. In a closed-form model, an entity employs an equation to estimate
the fair-value-based measure by using key determinants of a stock option’s value, such as the current
market price of the underlying share, exercise price, expected volatility of the underlying share, time
to exercise (i.e., expected term), dividend rate, and a risk-free interest rate for the expected term of the
award. Because of the nature of the formula, those inputs are held constant throughout the option’s term.
The key difference between a closed-form model and a lattice model is that in a lattice model, entities
may assume variations to the inputs during the contractual term of the award. The selection of an
appropriate valuation technique will therefore depend on the substantive characteristics of the award
being valued. For example, with a lattice model, the expected term of the award is an output that will
depend on a grantee’s exercise and postvesting behavior. The lattice model also allows entities to vary
the volatility of the underlying share price, the risk-free interest rate, and the expected dividends on the
underlying shares, since changes in these factors are expected to occur over the contractual term of the
option. A lattice approach can be used to directly model the effect of different expected periods before
exercise on the fair-value-based measure of the option, whereas it is assumed under the Black-Scholes-
Merton model that exercise occurs at the end of the option’s expected term.
152
A lattice model may therefore be better suited to capture and reflect the substantive characteristics of
certain types of share-based payment awards. For example, it would generally not be appropriate for an
entity to use the Black-Scholes-Merton model to value a stock option in which the exercisability depends
on a specified increase in the price of the underlying shares (i.e., a market condition). This is because
the Black-Scholes-Merton model is not designed to take into account this type of market condition and
therefore does not incorporate all of the substantive characteristics unique to the stock option that is
being valued. However, a lattice model such as a Monte Carlo simulation can be used to determine the
fair-value-based measure of an award containing a market condition. This is because it can incorporate
path-dependent options related to when the market condition will be met, thereby reflecting the
substantive characteristics of the stock option being valued. Whether it is practical to use a lattice model
is based on a variety of factors, including the availability of reliable data to support the variations in
the inputs. Entities should develop reasonable and supportable estimates for inputs and underlying
assumptions, regardless of the valuation technique applied.
The Interpretive Response to Question 2 of SAB Topic 14.C states that the SEC staff understands that
an entity may consider multiple techniques or models that meet the fair-value-based measurement
objective and that the entity would not be required to select a model (e.g., a lattice model) “simply
because that model [is] the most complex of the models . . . considered.” If an entity’s choice of model or
technique meets the fair-value-based measurement objective, the SEC will not object to it.
Entities may use a different valuation technique to estimate the fair-value-based measure of different
types of share-based payment awards. However, they should use the selected model consistently for
similar types of awards with similar characteristics. For example, an entity may use a lattice model to
estimate the fair-value-based measure of awards with market conditions and use the Black-Scholes-
Merton formula to estimate the fair-value-based measure of awards that contain only a service or
performance condition. In addition, an entity may use a lattice model to estimate the fair-value-based
measure of employee stock options and the Black-Scholes-Merton formula to estimate the fair-value-
based measure of awards in an employee stock purchase plan (ESPP).
Regardless of the valuation technique used, an option’s value is generally composed of its intrinsic value
and time value. Intrinsic value is the excess of the fair value of the underlying stock over the exercise
price. In many cases, options are granted “at the money,” which means the exercise price is equal to the
fair value of the underlying stock (i.e., the intrinsic value is zero). If the fair value of the underlying stock
exceeds the exercise price, the option is “in the money,” and if the fair value of the underlying stock is
less than the exercise price, the option is “out of the money,” or “underwater.”
The excess of the total fair value of an option over its intrinsic value is referred to as time value. While
an option may not have intrinsic value at the time of grant, all options typically have time value. This is
because the holder of an option (1) does not have to pay the exercise price until the option is exercised
and (2) has the ability to profit from appreciation of the underlying stock while limiting its loss or
downside risk. Therefore, all else being equal, the longer the time until option expiration and the higher
the volatility of the underlying stock, the greater the time value. See Section 4.9.2 for a discussion of the
effect of the various inputs used in an option pricing model on the estimation of the fair-value-based
measure of a share-based payment award.
153
4.9.1 Change in Valuation Technique

ASC 718-10
55-20 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.
Consistent Use of Valuation Techniques and Methods for Selecting Assumptions

55-27 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.

Question 3: In subsequent periods, may a company change the valuation technique or model chosen to value
instruments with similar characteristics?26
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.27 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. 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.28 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.29
26
FASB ASC paragraph 718-10-55-17 indicates that an entity may use different valuation techniques or models for
instruments with different characteristics.
27
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.
28
29
See generally FASB ASC paragraph 718-10-50-1.
154
SAB Topic 14.D, Certain Assumptions Used in Valuation Methods [Excerpt; Reproduced in ASC 718-10-S99-1]
FASB ASC Topic 718’s (Compensation — Stock Compensation Topic) fair value measurement objective for
equity instruments awarded to employees is to estimate the grant-date fair value of the equity instruments
that the entity is obligated to issue when employees have rendered the requisite service and satisfied any
other conditions necessary to earn the right to benefit from the instruments.30 In order to meet this fair value
measurement objective, management will be required to develop estimates regarding the expected volatility
of its company’s share price and the exercise behavior of its employees. The staff is providing guidance in the
following sections related to the expected volatility and expected term assumptions to assist public entities in
applying those requirements.
The staff understands that companies may refine their estimates of expected volatility and expected term
as a result of the guidance provided in FASB ASC Topic 718 and in sections (1) and (2) below. Changes in
assumptions during the periods presented in the financial statements should be disclosed in the footnotes.31

30

31
In the Interpretive Response to Question 3 of SAB Topic 14.C, the SEC staff indicated that an entity
may change its valuation technique or model as long as the new technique or model meets the fair-
value-based measurement objective in ASC 718 (see Section 4.9 for more information about selecting
a technique for valuing a share-based payment award). However, the staff also stated that it would not
expect an entity to frequently switch between valuation techniques or models, especially when there is
“no significant variation in the form of share-based payments being valued.” An entity should change its
valuation technique or model only to improve the estimate of the fair-value-based measure, not simply
to reduce the amount of compensation cost recognized.
An entity’s change to its valuation technique, model, or assumptions should be accounted for as
a change in estimate and should be applied prospectively to new or modified awards. A change in
valuation method will not affect the fair-value-based measure of previously issued awards; awards
issued before the application of the new technique should not be remeasured or revalued unless they
are modified.
155
4.9.2 Assumptions in an Option Pricing Model

ASC 718-10
Selecting Assumptions for Use in an Option Pricing Model

55-21 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 718-10-55-29 through 55-34, 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 718-10-55-44 through 55-45).
f. The risk-free interest rate(s) for the expected term of the option.
55-22 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.
55-23 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.
While ASC 718 does not require entities to use a particular valuation model to determine the fair-value-
based measure of options and similar instruments, the valuation model used must, at a minimum,
incorporate the following inputs in accordance with ASC 718-10-55-21:

• The expected term of the award.
• The current market price of the underlying share.
• The expected volatility of the underlying share price over the expected term of the award.
• The expected dividends on the underlying share over the expected term of the award.
• The risk-free interest rate over the expected term of the award.
If a lattice model is used, the expected term would be an output of the model. Accordingly, the
expected volatility, expected dividends, and risk-free interest rate would be determined for the option’s
contractual term.
156
An individual option pricing model input that fluctuates might affect the other inputs. For example,
as volatility increases, more option holders might take advantage of the increases in share prices by
exercising their options earlier. The increase in the number of exercises will affect the expected term,
which in turn may necessitate an adjustment to the expected dividend and risk-free interest rates.
Therefore, as long as all other variables are held constant, the effects of a change in each individual
input factor on the fair-value-based measure of a stock option are as follows:
• Exercise price of the award and current market price of the underlying share — The current market
price of the underlying share for an award granted by a public entity is usually the quoted
market price of the entity’s common stock on the grant date. (If the share has a postvesting
restriction, see Section 4.8.1 for guidance on incorporating the postvesting restriction in the
option pricing model.) The exercise price is the amount of cash a grantee is required to pay to
exercise the award. An increase in the exercise price will result in a decrease in the award’s fair-
value-based measure, whereas an increase in the current market price will result in an increase
in that measure. Accordingly, the relationship between the exercise price of an award and
the current market price of the entity’s common stock will affect the award’s fair-value-based
measure. That is, on the grant date, an option that is issued in the money (i.e., the exercise price
is less than the current market price of the entity’s common stock so the option has intrinsic
value) will have a greater fair-value-based measure than an option issued at the money or out of
the money.
• Expected term of the award — The expected term of an award is the period during which the
award is expected to be outstanding (i.e., the period from the service inception date, which is
usually the grant date, to the date of expected exercise or settlement). An award’s fair-value-
based measure increases as its expected term increases as a result of the increase in the
award’s time value. The time value of an award is the portion of an award’s fair-value-based
measure that is based on (1) the amount of time remaining until the expiration date of the
award and (2) the notion that the underlying components that constitute the value of the award
may change during that time. See Section 4.9.2.2 for a discussion of factors to consider in the
estimation of the expected term of an award and of the SEC staff’s views on estimating the
expected term.
• Expected volatility of the underlying share price — Expected volatility of the underlying share price
is a probability-weighted measure of the expected dispersion of share prices about the mean
share price over the expected term of the award. The fair value of an option increases with
an increase in volatility. A high volatility indicates a greater fluctuation in the share price (up
or down from the mean share price), potentially resulting in a greater benefit for the option
holder. For example, if an option is issued at the money, the holder of an option with a highly
volatile share price will be more likely to exercise the option when the share price fluctuates
to a higher value (and sell that share for a profit) than a holder of a similar option with a less
volatile underlying share price. See Section 4.9.2.3 for a discussion of factors to consider in the
estimation of the expected volatility of the underlying share price and of the SEC staff’s views on
estimating the expected volatility.
• Expected dividends on the underlying share — The expected dividends on the underlying share
represent the expected dividends or dividend rate that will be paid out on the underlying shares
during the expected term of the award. Expected dividends should be included in the valuation
model only if the award holders are not entitled to receive those dividends before exercise.
Consequently, as expected dividends increase, the fair-value-based measure of the award
decreases. See Section 4.9.2.4 for a discussion of how dividends paid on stock options before
exercise affect the valuation of such awards.
157
• Risk-free interest rate for the expected term of the award — The risk-free rate is a theoretical rate at
which an investment earns interest without incurring any risk (i.e., the valuation is risk neutral).
This risk-neutral notion is used extensively in option pricing theory, under which all assets may
be assumed to have expected returns equal to the risk-free rate. Higher interest rates will
increase the fair-value-based measure of an award by increasing the award’s time value. See
Section 4.9.2.1 for guidance on selecting an appropriate risk-free interest rate.
The effect of an increase in each of the above inputs (assuming that all other inputs remain constant) is
summarized in the table below.
Increase in Input Effect on Award’s Fair Value
Current market price of underlying share Increase
Exercise price Decrease
Expected term Increase
Expected volatility Increase
Expected dividends Decrease
Risk-free interest rate Increase
Developing assumptions to be used in an option-pricing model generally involves assessing historical

experience and considering whether such historical experience is relevant to the development of future
expectations. See ASC 718-10-55-24 and 55-25 below.
ASC 718-10
55-24 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 718-10-55-35 through 55-41 provide
further guidance on estimating expected volatility.
158
55-25 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.
4.9.2.1 Risk-Free Interest Rate

ASC 718-10
Selecting or Estimating the Risk-Free Rate for the Expected Term

55-28 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 risk-free interest rate is the theoretical rate of return of an investment with zero risk (since option
pricing models are risk-neutral valuations). The risk-free interest rate represents the interest an investor
would expect from a risk-free investment over a specified period. This rate is associated with the time
value of money since an option holder does not have to pay for the underlying stock until the option
is exercised. In the United States, the risk-free interest rate is assumed to be a treasury rate, with a
remaining term equal to the expected term of the award (e.g., U.S. Treasury zero-coupon issues).
4.9.2.2 Expected Term
ASC 718-10
159
Selecting or Estimating the Expected Term

55-29 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).
55-29A 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.
55-30 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.
160
55-31 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).
55-32 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.
ASC 718-10-S99-1]
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 the holder 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 options
value [compared to a transferable option] because exercise prior to the options 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.
The staff believes the estimate of expected term should be based on the facts and circumstances available
in each particular case. Consistent with our guidance regarding reasonableness immediately preceding Topic
14.A, 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?
161
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.66
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
employees render the requisite service.67
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.68 . . .
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.70 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.71
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,72 or a lack of
variety of price paths that the company may have experienced.73
66
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, forthcoming, 2005.
67
68
70
71
Historical share option exercise experience encompasses data related to share option exercise, post-vesting termination,
and share option contractual term expiration.
72
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.
73
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.
162
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.74 In addition, FASB ASC paragraph 718-10-55-32 states “. . . 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.
While such comparative information may not be widely available at present, the staff understands that various
parties, including actuaries, valuation professionals and others are gathering such data.

74
ASC 718 does not specify a method for estimating the expected term of an award; however, such a
method must be objectively supportable. Similarly, historical observations should be accompanied by
information about why future observations are not expected to change, and any adjustments to these
observations should be supported by objective data. ASC 718-10-55-31 provides the following factors an
entity may consider in estimating the expected term of an award:
• The vesting period of the award — Options generally cannot be exercised before vesting; thus, an
option’s expected term cannot be less than its vesting period.
• Historical exercise and postvesting employment termination behavior for similar grants — Historical
experience should be an entity’s starting point in determining expectations of future exercise
and postvesting behavior. Historical exercise patterns should be modified when current
information suggests that future behavior will differ from past behavior. For example, rapid
increases in an entity’s stock price after the release of a new product in the past could have
caused more grantees to exercise their options as soon as the options vested. If a similar
increase in the entity’s stock price is not expected, the entity should consider whether adjusting
the historical exercise patterns is appropriate.
• Expected volatility of the underlying share price — An increase in the volatility of the underlying
share price tends to result in an increase in exercise activity because more grantees take
advantage of increases in an entity’s share price to realize potential gains on the exercise of the
option and subsequent sale of the underlying shares. ASC 718-10-55-31(c) states, “An entity also
might consider whether the evolution of the share price affects [a grantee’s] exercise behavior
(for example, [a grantee] 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).” The exercise
behavior based on the evolution of an entity’s share price can be more easily incorporated into a
lattice model than into a closed-form model.
• Blackout periods — A blackout period is a period during which exercise of an option is

contractually or legally prohibited. Blackout periods and other arrangements that affect the
exercise behavior associated with options can be included in a lattice model. Unlike a closed-
form model, a lattice model can be used to calculate the expected term of an option by taking
into account restrictions on exercises and other postvesting exercise behavior.
• Employees’ ages, lengths of service, and home jurisdictions — Historical exercise information could
have been affected by the profile of the employee group. For example, during a bull market,
some entities are more likely to have greater turnover of employees since more opportunities
are available. Many such employees will exercise their options as early as possible. These
historical exercise patterns should be adjusted if similar turnover rates are not expected to
recur in the future.
163
If historical exercise and postvesting behavior are not readily available or do not provide a reasonable
basis upon which to estimate the expected term, alternative sources of information may be used. For
example, an entity may use a lattice model to estimate the expected term (the expected term is not
an input in the lattice model but rather is inferred on the basis of the output of the lattice model). In
addition, an entity may consider using other relevant and supportable information such as industry
averages or published academic research. When an entity takes external peer group information
into account, there should be evidence that such information has been sourced from entities with
comparable facts and circumstances. Further, entities may use practical expedients to estimate the
expected term for certain awards. See Section 4.9.2.2.2 for a discussion of a public entity’s use of the
SEC’s “simplified method” to estimate the expected term for “plain-vanilla” options. See Section 4.9.2.2.3
for a discussion of a nonpublic entity’s use of a practical expedient to estimate the expected term for
certain options that is similar to the simplified method available to public entities.
Changing Lanes
As discussed above, an entity measures stock options under ASC 718 by using an expected term
that takes into account the effects of grantees’ expected exercise and postvesting behavior.
However, determining an expected term for nonemployee awards could be challenging
because entities may not have sufficient historical data related to the early exercise behavior
of nonemployees, particularly if nonemployee awards are not frequently granted. In addition,
nonemployee stock option awards may not be exercised before the end of the contractual
term if they do not contain certain features typically found in employee stock option awards
(e.g., nontransferability, nonhedgeability, and truncation of the contractual term because of
postvesting service termination). Accordingly, ASC 718 allows an entity to elect on an award-by-
award basis to use the contractual term as the expected term for nonemployee awards. If an
entity elects not to use the contractual term for a particular award, the entity must estimate the
expected term. However, a nonpublic entity can make an accounting policy election to apply a
practical expedient to estimate the expected term for awards that meet the conditions in ASC
718-10-30-20B (see discussion in Section 9.4.2.1). See Section 9.4.1 for additional information.
In accordance with ASC 718-10-55-29A, if an entity does not elect to use the contractual term as
the expected term for a particular award and, for a nonpublic entity, does not apply the practical
expedient to estimate the expected term, the entity should consider factors similar to those in
ASC 718-10-55-29 when estimating the expected term for nonemployee awards.
4.9.2.2.1 Aggregation Into Homogenous Groups

ASC 718-10
55-33 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.
55-34 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.
164
ASC 718-10-S99-1]
Question 4: FASB ASC paragraph 718-10-55-34, indicates 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.69
The staff believes the focus should be on groups of employees with significantly different expected exercise behavior.
69
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.
When estimating the expected-term assumption, entities should aggregate individual awards into
relatively homogeneous groups if identifiable groups of grantees display or are expected to display
significantly different exercise behaviors. For employee groupings, the SEC staff believes that a
reasonable fair-value-based estimate can be made on the basis of as few as one or two groupings. The
SEC staff believes that the focus should be on groups of employees with significantly different exercise
behavior, such as executives and nonexecutives.
4.9.2.2.2 Simplified Method for Public Entities

ASC 718-10-S99-1]
Facts: Company E grants equity share options to its employees that have the following basic characteristics:75
The share options are granted at-the-money;
Exercisability is conditional only on performing service through the vesting date;76
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?
Employee share options with these features are sometimes referred to as plain-vanilla options.
75
In this fact pattern the requisite service period equals the vesting period.
76
165
Interpretive Response: As noted above, 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.77 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.78
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.
Also, as noted above in Question 5, the staff believes that more detailed external information about exercise
behavior will, over time, become readily available to companies. As such, 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.
77
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.
78
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,” forthcoming
in the Journal of Financial Economics. 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.
166
If a public entity concludes that “its historical share option exercise experience does not provide a
reasonable basis upon which to estimate expected term,” the entity may use what the SEC staff describes
as a “simplified method” to develop the expected-term estimate. (A practical expedient similar to the
simplified method is available to nonpublic entities; see Section 4.9.2.2.3.) Under the simplified method,
the public entity uses an average of the vesting term and the original contractual term of an award. The
method applies only to awards that qualify as “plain-vanilla” options (see Section 4.9.2.2.2.1).
The SEC staff believes that public entities should stop using the simplified method for stock option
grants if more detailed external information about exercise behavior becomes available. In addition, the
staff issues comments related to the use of the simplified method and, in certain instances, registrants
have been asked to explain why they believe that they were unable to reasonably estimate the expected
term on the basis of their historical stock option exercise information.
In accordance with the SEC’s guidance in Question 6 of SAB Topic 14.D.2 (see above), a registrant that
uses the simplified method should disclose in the notes to its financial statements (1) that the simplified
method was used, (2) the reason the method was used, (3) the types of stock option grants for which the
simplified method was used if it was not used for all stock option grants, and (4) the period(s) for which
the simplified method was used if it was not used in all periods presented.
4.9.2.2.2.1 Characteristics of a Plain-Vanilla Option

As the SEC states in SAB Topic 14.D.2, the simplified method applies only to awards that qualify as plain-
vanilla options. A share-based payment award must possess all of the following characteristics to qualify
as a plain-vanilla option:
• “The share options are granted at-the-money.”

• “Exercisability is conditional only on performing service through the vesting date” (i.e., the
requisite service period equals the vesting period).
• “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).”
• “The share options are nontransferable and nonhedgeable.”

If an award has a performance or market condition, it would not be considered a plain-vanilla option.
The examples below illustrate two types of awards, among other types, that do not qualify as plain-
vanilla options and therefore would not be eligible for the simplified method of estimating the expected
term of an award. Entities should evaluate all awards to determine whether they qualify as plain-vanilla
options.
Example 4-1A
In 20X1, an entity granted employee stock options and used the simplified method to estimate the options’
expected term. After the original grant date, the entity established that it had incorrectly determined the grant
date for its options granted in 20X1 and that the options were actually granted in the money. Because the
options were not granted at the money, they do not qualify as plain-vanilla options.
167
Example 4-2
In 20X1, an entity granted employee stock options that either (1) vest at the end of the seventh year of service
or (2) accelerate vesting if certain defined EBITDA targets are met before that date. Because the options’
exercisability depends on a performance condition as well as a service condition, they do not qualify as plain-
vanilla options.
4.9.2.2.2.2 Calculating the Expected Term by Using the Simplified Method

The examples below illustrate how to calculate the expected term for plain-vanilla options with a graded-
vesting schedule and a cliff-vesting schedule.
Example 4-3
Simplified Method for an Award With Graded Vesting

An entity grants at-the-money employee stock options, each with a contractual term of 10 years. The options
meet the criteria for plain-vanilla options outlined in Question 6 of SAB Topic 14.D.2 and vest in 33.3 percent
increments (tranches) each year over the next three years. Therefore, under the simplified method, the
expected term of the options would be six years, calculated as follows:
1-year vesting term × first 33.3% vested = 0.33

+
2-year vesting term × second 33.3% vested = 0.67
+
3-year vesting term × last 33.3% vested = 1.00
2.00
10-year contractual term + 10.00
12.00
Divide by 2 (average) ÷ 2.00
6.00 years
Or, {[(1 + 2 + 3) ÷ 3] + 10} ÷ 2 = 6 years.
Example 4-4
Simplified Method for an Award With Cliff Vesting

An entity grants at-the-money employee stock options, each with a contractual term of 10 years. The options
meet the criteria for plain-vanilla options outlined in Question 6 of SAB Topic 14.D.2. The options vest at the
end of the fourth year of service. Therefore, under the simplified method, the expected term of the awards
would be 7 years, or (4-year vesting term + 10-year contractual life) ÷ 2.
168
4.9.2.2.3 Expected-Term Practical Expedient for Nonpublic Entities

ASC 718-10
Nonpublic Entity — Practical Expedient for Expected Term

30-20A 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 718-10-55-69 through
55-79 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.
30-20B 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.

55-34A 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 718-10-30-20A
through 30-20B). Paragraph 718-10-55-50A provides implementation guidance on the practical expedient.
Nonpublic Entity — Practical Expedient for Expected Term

55-50A 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.
169
A nonpublic entity may make an entity-wide accounting policy election to estimate the expected term of
its awards by using a practical expedient similar to the simplified method available to public companies
(see Section 4.9.2.2.2). Awards for which the practical expedient may be used must have satisfied
all the requirements described in ASC 718-10-30-20B above. Those requirements are similar to the
conditions that must be met for public entities to use the simplified method, but there are some notable
differences. For example, nonpublic entities can apply the practical expedient to awards with service
or performance conditions; however, public entities can apply the simplified method only to awards
with service conditions. In addition, to use the simplified method, a public company is required under
SAB Topic 14.D.2 to “conclude that its historical share option exercise experience does not provide a
reasonable basis upon which to estimate [the] expected term” of its awards, whereas a nonpublic entity
can elect to use the practical expedient irrespective of its historical exercise experience.
The practical expedient for nonpublic entities also applies to liability-classified awards measured at a
fair-value-based amount even if the award ceases to be at the money upon remeasurement. For these
awards, an entity should update its estimate of the expected term as of each reporting period until
settlement. The updated estimate should reflect any change in the assessment of whether it is probable
that a performance condition will be met (if applicable).
Determination of the expected term under this practical expedient is based on whether the awards have
service or performance conditions. If vesting depends only on a service condition, the expected term
is the midpoint between the employee’s requisite service period or the nonemployee’s vesting period
and the contractual term of the award. For example, if the requisite service period is 4 years and the
contractual term is 10 years, the expected term would be 7 years. If vesting is based on satisfaction of
a performance condition, the expected term depends on whether it is probable that the performance
condition will be met. If it is probable that the performance condition will be met, the expected term
is the midpoint between the employee’s requisite service period or the nonemployee’s vesting period
(whether explicit or implicit) and the contractual term of the award. However, if it is not probable that
the performance condition will be met, the expected term can be either (1) the contractual term of the
award if the vesting period is implied (see Section 3.6.2) or (2) the midpoint between the employee’s
requisite service period or the nonemployee’s vesting period and the contractual term of the award if
the service period is explicitly stated (see Section 3.6.1).
For nonemployee awards, a nonpublic entity may elect the practical expedient in ASC 718-10-30-20A
described above. However, on an award-by-award basis, a nonpublic entity can always elect to estimate
the fair value of the award by using the contractual term as the expected term. If a nonpublic entity
elects to use this practical expedient, it must do so for all nonemployee awards that meet the criteria
described in ASC 718-10-30-20B and for which the nonpublic entity does not use the contractual term.
170
The flowchart below shows how to determine the expected term under the practical expedient for
nonpublic entities.
Does the award

contain only a service Yes
condition (i.e., there
are no performance
conditions)?1
No
The expected term is the midpoint

Is it probable that the Yes between the employee’s requisite
performance condition will service period or the nonemployee’s
be met? vesting period and the contractual
term of the award.
No
Is the vesting
period explicitly
stated (see Section 3.6.1)
or implied? (See Section Explicitly Stated
3.6.2.)
Implied
The expected term is the

contractual term of the award.
1
If the award contains market conditions, the use of this practical expedient is not permitted.
171
4.9.2.3 Expected Volatility
ASC 718-10
55-25 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.
Selecting or Estimating the Expected Volatility

55-35 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.
55-36 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.
55-37 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.
172
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.
55-38 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.
55-39 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.
55-40 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.
55-41 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).
SAB Topic 14.D.1, Certain Assumptions Used in Valuation Methods: Expected Volatility [Excerpt;
Reproduced in ASC 718-10-S99-1]
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 options
value is dependent on potential share returns over the options term. The higher the volatility, the more the
returns on the share can be expected to vary — up or down. Because an options 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?
173
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.32 FASB ASC Topic 718 provides a list of factors entities should consider in estimating
expected volatility.33 Company B may begin its process of estimating expected volatility by considering its
historical volatility.34 However, Company B should also then consider, based on available information, how the
expected volatility of its share price may differ from historical volatility.35 Implied volatility36 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.
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 options37 generally could place greater (or even exclusive) reliance on implied volatility. (See the
Interpretive Responses to Questions 3 and 4 below.)
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, a simple
convertible bond) can, in some cases, be impracticable due to the complexity of multiple features.
32
33
34
35
Ibid.
36
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.
37
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.
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.57 Under that guidance, Company B is required to disclose the
expected volatility and the method used to estimate it.58 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.
174
In addition, Company B should consider the applicability of SEC Release No. FR-60 and Section V, “Critical
Accounting Estimates,” in SEC Release No. FR-72 regarding critical accounting policies and estimates in MD&A.
The staff would expect such disclosures to include an explanation of the method used to estimate the expected
volatility of its share price. This explanation generally should include a discussion of the basis for the company’s
conclusions regarding the extent to which it used historical volatility, implied volatility or a combination of both.
A company could consider summarizing its evaluation of the factors listed in Questions 2 and 3 of this section
as part of these disclosures in MD&A.
FASB ASC Section 718-10-50.

57
FASB ASC subparagraph 718-10-50-2(f) (2) (ii).

58
Volatility is a measure of the amount by which a share price has fluctuated (historical volatility) or is
expected to fluctuate (expected volatility) during a period. In option pricing models, expected volatility is
required to be an assumption because the option’s value is based on potential share returns over the
option’s term. ASC 718 does not specify a method for estimating the expected volatility of the underlying
share price; however, ASC 718-10-55-35 clarifies that the objective of such estimation is to ascertain
the “assumption about expected volatility [of the underlying share price] that marketplace participants
would be likely to use in determining an exchange price for an option.”
ASC 718-10-55-37 lists factors that entities would consider in estimating the expected volatility of the
underlying share price. The method selected to perform the estimation should be applied consistently
from period to period, and entities should adjust the factors or assign more weight to an individual
factor only on the basis of objective information that supports such adjustments. The Interpretive
Response to Question 1 of SAB Topic 14.D.1 notes that entities should incorporate into the estimate any
relevant new or different information that would be useful. Further, they 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” of
the underlying share price. See Section 4.9.2.3.1 through Section 4.9.2.3.3 for additional discussion of
the SEC staff’s views on estimating the expected volatility of an underlying share price.
Entities would consider the following factors in estimating expected volatility:
• Historical volatility of the underlying share price — Entities typically value stock options by using
the historical volatility of the underlying share price. Under a closed-form model, such volatility
is based on the most recent volatility of the share price over the expected term of the option;
under a lattice model, it is based on the contractual term. ASC 718-10-55-37(a) states that an
entity may disregard the volatility of the share price for an identifiable period if the volatility
resulted from a condition (e.g., a failed takeover bid) specific to the entity, and the condition is
not expected to recur during the expected or contractual term. If the condition is not specific to
the entity (e.g., general market declines), the entity generally would not be allowed to disregard
or place less weight on the volatility of its share price during that period unless objectively
verifiable evidence supports the expectation that market volatility will revert to a mean that will
differ materially from the volatility during the specified period. The SEC staff believes that an
entity’s decision to disregard a period of historical volatility should be based on one or more
discrete and specific historical events that are not expected to occur again during the term
175
of the option. In addition, the entity should not give recent periods more weight than earlier
periods.
In certain circumstances, an entity may rely exclusively on historical volatility. However, because
the objective of estimating expected volatility is to ascertain the assumptions that marketplace
participants are likely to use, exclusive reliance may not be appropriate if there are future
events that could reasonably affect expected volatility (e.g., a future merger that was recently
announced). See Section 4.9.2.3.1 for the SEC staff’s views on the computation of historical
volatility and on circumstances in which an entity can rely exclusively on historical volatility.
• Implied volatility of the underlying share price — The implied volatility of the underlying share price
is not the same as the historical volatility of the underlying share price because it is derived from
the market prices of an entity’s traded options or other traded financial instruments with option-
like features and not from the entity’s own shares. Entities can use the Black-Scholes-Merton
formula to calculate implied volatility by including the fair value of the option (i.e., the market price
of the traded option) and other inputs (stock price, exercise price, expected term, dividend rate,
and risk-free interest rate) in the calculation and solving for volatility. When valuing employee
or nonemployee stock options, entities should carefully consider whether the implied volatility
of a traded option is an appropriate basis for expected volatility of the underlying share price.
For example, traded options usually have much shorter terms than employee or nonemployee
stock options, and the calculated implied volatility may not take into account the possibility of
mean reversion. To compensate for mean reversion, entities use statistical tools for calculating a
long-term implied volatility. For example, entities with traded options whose terms range from 2
to 12 months can plot the volatility of these options on a curve and use statistical tools to plot a
long-term implied volatility for a traded option with an expected or a contractual term equal to an
employee or nonemployee stock option.
Generally, entities that can observe sufficiently extensive trading of options and can therefore
plot an accurate long-term implied volatility curve should place greater weight on implied
volatility than on the historical volatility of their own share price (particularly if they do not meet
the SEC’s conditions for relying exclusively on historical volatility). That is, a traded option’s
volatility is more informative in the determination of expected volatility of an entity’s stock price
than historical stock price volatility, since option prices take into account the option trader’s
forecasts of future stock price volatility. In determining the extent of reliance on implied volatility,
an entity should consider the volume of trading in its traded options and its underlying shares,
the ability to synchronize the variables used to derive implied volatility (as close to the grant
date of employee or nonemployee stock options as reasonably practicable), the similarity of
the exercise prices of its traded options to its employee or nonemployee stock options, and
the length of the terms of its traded options and employee or nonemployee stock options. See
Section 4.9.2.3.2 for a discussion of the SEC staff’s views on the extent of reliance on implied
volatility and on circumstances in which an entity can rely exclusively on implied volatility.
• Limitations on availability of historical data — Public entities should compare the length of time an
entity’s shares have been publicly traded with the expected or contractual term of the option. A
newly public entity may also consider the expected volatility of the share prices of similar public
entities. In determining comparable public entities, that entity would consider factors such as
industry, stage of life cycle, size, and financial leverage. See Section 4.9.2.3.3 for a discussion of
the SEC staff’s views on the use of comparable public entities to estimate expected volatility.
Nonpublic entities may also base the expected volatility of their share prices on the expected
volatility of similar public entities’ share prices, and they may consider the same factors as those
described above for a newly public entity. When a nonpublic entity is unable to reasonably
estimate its entity-specific volatility or that of similar public entities, it may use a calculated value.
176
See Section 4.13.2 for a discussion of when a nonpublic entity may use the historical volatility of
an appropriate industry sector index and what a nonpublic entity should consider in selecting
and computing the historical volatility of an appropriate industry sector index.
• Data intervals — An entity that considers the historical volatility of its share price when estimating
the expected volatility of its share price should use intervals for price observations that (1) are
appropriate on the basis of its facts and circumstances (e.g., given the frequency of its trades
and the length of its trading history) and (2) provide a basis for a reasonable estimate of a fair-
value-based measure. Daily, weekly, or monthly price observations may be sufficient; however,
if an entity’s shares are thinly traded, weekly or monthly price observations may be more
appropriate than daily price observations. See the next section for a discussion of the SEC staff’s
views on frequency of price observations.
• Changes in corporate and capital structure — An entity’s corporate and capital structure could
affect the expected volatility of its share price (e.g., share price volatility tends to be higher for
highly leveraged entities). In estimating expected volatility, an entity should take into account
significant changes to its corporate and capital structure, since the historical volatility of a share
price for a period when the entity was, for example, highly leveraged may not represent future
periods when the entity is not expected to be highly leveraged (or vice versa).
4.9.2.3.1 Historical Volatility
The SEC staff provides the following guidance on computing historical volatility of the underlying share
price in the valuation of a share-based payment award:
Question 2: What should Company B consider if computing historical volatility?38
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 Company B’s expectations about its future volatility over the expected (if using
a Black-Scholes-Merton closed-form model) or contractual (if using a lattice model) term39 of its employee share
options. Certain methods may not be appropriate for longer term employee share options if they weight the
most recent periods of Company B’s historical volatility much more heavily than earlier periods.40 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.41
See FASB ASC paragraph 718-10-55-37.

38
For purposes of this staff accounting bulletin, the phrase expected or contractual term, as applicable has the same meaning
39
as the phrase expected (if using a Black-Scholes-Merton closed-form model) or contractual (if using a lattice model) term of an
employee share option.
FASB ASC subparagraph 718-10-55-37(a) states that entities should consider historical volatility over a period generally
40
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.
Generalized Autoregressive Conditional Heteroskedasticity (GARCH) is an example of a method that demonstrates this
41
characteristic.
177
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.42 Company B should select a
consistent point in time within each interval when selecting data points.43
42
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.
43
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 to employees 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.44 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.
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.45 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.
44
45
178
In addition, the SEC staff provides the following guidance on determining when an entity may rely
exclusively on historical volatility in estimating expected 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.51 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 a price for an option.52 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. . . .
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;55
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.56
FASB ASC paragraphs 718-10-55-36 through 718-10-55-37.

51
FASB ASC paragraph 718-10-55-35. . . .

52
FASB ASC paragraph 718-10-55-38. A change in a company’s business model that results in a material alteration to the
55
company’s risk profile is an example of a circumstance in which the company’s future volatility would be expected to
differ from its past 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.
If the expected or contractual term, as applicable, of the employee share option is less than three years, the staff believes
56
monthly price observations would not provide a sufficient amount of data.
179
4.9.2.3.2 Implied Volatility
The SEC staff provides the following guidance on the extent of an entity’s reliance on implied volatility in
estimating expected volatility:
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 718-10-55-35 through 718-10-55-41, 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 employee share
options; and
4) the similarity of the length of the term of the traded and employee share options.46
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 participants 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 employee 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 employee share options as reasonably practicable.
3. Similarity of the Exercise Prices
The staff believes that when valuing an at-the-money employee share option, the implied volatility derived
from at- or near-the-money traded options generally would be most relevant.47 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 employee share option.48
46
See generally Options, Futures, and Other Derivatives by John C. Hull (Prentice Hall, 5th Edition, 2003).
47
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, 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.
48
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 employee 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.
180
4. Similarity of Length of Terms
The staff believes that when valuing an employee 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 options 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.49 However, when using traded options with a term of less than
one year,50 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 employee share option.
The staff believes Company B’s evaluation of the factors above should assist in determining whether the
implied volatility appropriately reflects the markets expectations of future volatility and thus the extent of
reliance that Company B reasonably places on the implied volatility.
The staff believes it may also be appropriate to consider the entire term structure of volatility provided by traded options
49
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.
The staff believes the implied volatility derived from a traded option with a term of one year or greater would typically not
50
be significantly different from the implied volatility that would be derived from a traded option with a significantly longer
term.
In addition, the SEC staff provides the following guidance on when it may be acceptable for an entity to
rely exclusively on implied volatility in estimating expected 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.51 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 a price for an option.52 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.
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 employee
share options;53
The implied volatility is derived from options that are actively traded;

51

52
FASB ASC paragraphs 718-10-55-18 and 718-10-55-39 discuss the incorporation of a range of expected volatilities into
53
option pricing models. The staff believes that a company that utilizes an option pricing model that incorporates a range
of expected volatilities over the options 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.
181
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 grant date of the employee share
options;
The traded options have exercise prices that are both (a) near-the-money and (b) close to the exercise price of
the employee share options;54 and
The remaining maturities of the traded options on which the estimate is based are at least one year. . . .
54
When near-the-money options are not available, the staff believes the use of a weighted-average approach, as noted in a
previous footnote, may be appropriate.
4.9.2.3.3 Estimating Expected Volatility by Using Other Comparable Entities

If an entity is newly public or nonpublic, it may have limited historical data and no other traded financial
instruments from which to estimate expected volatility. In such cases, as discussed in the SEC guidance
below, it may be appropriate for the entity to base its estimate of expected volatility on the historical,
expected, or implied volatility of comparable entities.
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.59 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.60
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.61
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.62 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.63
59
FASB ASC paragraphs 718-10-55-25 and 718-10-55-51.
60
61
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.
62
63
182
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.64 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.65
64
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.
65
4.9.2.4 Expected Dividends
ASC 718-10
Selecting or Estimating Expected Dividends

55-42 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).
55-43 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.
Dividend Protected Awards

55-44 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 using an option-pricing model to estimate the fair-value-based measure of a stock option, an entity
usually takes into account expected dividends because dividends paid on the underlying shares are part
of the fair value of those shares, and option holders generally are not entitled to receive those dividends.
However, an award of stock options may be structured to protect holders by giving them dividend rights
that take various forms. An entity should appropriately reflect such dividend protection in estimating
the fair-value-based measure of a stock option. For example, the entity could appropriately reflect the
effect of the dividend protection by using an expected dividend yield input of zero if all dividends paid
183
to shareholders are applied to reduce the exercise price of the options being valued. For a discussion of
the recognition of dividends or dividend equivalents, see Section 3.10.
4.9.2.5 Credit Risk and Dilution

ASC 718-10
Selecting or Considering Credit Risk

55-46 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.
Consider Dilution
55-48 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.
55-49 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.
55-50 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.
ASC 718-10-55-46 states that in estimating the fair-value-based measure of share-based payment
awards that are classified as liabilities, “[a]n entity may need to consider the effect of its credit risk.” The
entity may need to do so if the award is settled in cash “because potential cash payoffs from the awards
are not independent of the entity’s risk of default.” Since the fair-value-based measure of awards that
are settled in cash typically increases with increases in the entity’s stock price, a significant credit risk
adjustment is not expected. However, if the opposite is true (i.e., the fair-value-based measure of the
award increases with decreases in the entity’s stock price), a credit risk adjustment may be necessary.
ASC 718 also indicates that a dilution adjustment for public entities is expected to be rare.
184
4.9.3 Market-Based Measure of Stock Options

In FASB Statement 123(R) (which was issued in 2004 and later codified as ASC 718), the Board observed
in paragraph B62 of the Basis for Conclusions that at some future date, market prices for equity share
options with conditions similar to those in certain employee options may become available. Currently, it
is not common for an entity to establish a fair-value-based measure for employee or nonemployee stock
options by issuing similar instruments to third-party investors. If such an approach is taken, entities
should exercise judgment in determining whether an option or similar instrument is being traded in
an active market and whether the instrument being traded is similar to the employee or nonemployee
stock option being valued.
In a memorandum issued in August 2005, the SEC’s Office of Economic Analysis (OEA) presented its
conclusions regarding a review of various market-based approaches for estimating the fair-value of
employee stock options. The OEA indicated that any market-based approach must contain the following
three elements:
• A market instrument that confers net payments on its holder that are equal in value to the fair value of
all or part of the employee stock option grant.[2], [3]
• A credible information plan that enables prospective buyers and sellers to price the instrument. For
example, the plan should provide information about the exercise behavior of the employees in the
grant. It should be easily accessible to all market participants to reduce the potential for adverse
selection.
• Aencourage
market pricing mechanism through which the instrument can be traded to generate a price. It should
participation in the market in order to promote competition among willing buyers and
sellers.
The OEA memorandum does not provide additional guidance on the last two elements above. However,
the OEA discussed two approaches related to instrument design: (1) the “tracking” approach and (2) a
“terms-and-conditions” approach. Under the tracking approach, an entity issues an instrument that
incorporates rights to future payouts that are identical to the future flows of net receipts by employees
or net obligations of the entity under the grant. Under a terms-and-conditions approach, an entity issues
an instrument that replicates the substantive terms and conditions of the employee stock options. For
example, the holder of the instrument would face the same restrictions against trading and hedging
that an employee faces under the terms of the granted options. On the basis of its analysis of each
approach, the OEA concluded that instruments designed for valuing employee stock options under
the tracking approach can yield reasonable estimates of fair value as defined in ASC 718. Conversely,
the OEA indicated that instruments designed under a terms-and-conditions approach do not result in
reasonable estimates of fair value.
4.10 Valuation of Awards With Graded Vesting Schedule

ASC 718-20
55-26 The choice of attribution method for awards with graded vesting schedules is a policy decision that is not
dependent on an entity’s choice of valuation technique. In addition, the choice of attribution method applies to
awards with only service conditions.
2
The OCA memorandum states, “Under the proposals that we have seen, the amount of market instruments that would be issued is a fraction of
the total option grant (generally 5–15 percent of the grant). Alternatively, a company could transfer part or all of its grant obligations to a third
party that would meet the grant’s stock delivery obligation. We have not evaluated the adequacy of any grant size or volume to the achievement of
the valuation objective.”
3
The OCA memorandum states that the “net payment may be in the form of securities or cash.”
185
Some share-based payment awards may have a graded vesting schedule (i.e., awards that are split
into multiple tranches in which each tranche legally vests separately). For example, an entity may grant
an employee 1,000 stock options that vest over four years in increments of 25 percent each year. As
discussed in Section 4.9.2.2, vesting indirectly affects the fair-value-based measure of a stock option
by affecting the expected-term assumption. For options and similar instruments with graded vesting,
an entity can either estimate separate fair-value-based measures for each vesting tranche, each with
a different expected term, or estimate the fair-value-based measure of the entire award by using a
single weighted-average expected term. Regardless of the valuation approach, for employee awards
with graded vesting and only service conditions, an entity can still make a policy decision to recognize
compensation cost on a straight-line basis over the total requisite service period of the entire award (see
Section 3.6.5).
4.11 Difficulty of Estimation
ASC 718-10
Difficulty of Estimation
30-21 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.
Intrinsic Value Method

30-22 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).
ASC 718-20
Fair Value Not Reasonably Estimable

35-1 An equity instrument for which it is not possible to reasonably estimate fair value at the grant date shall
be remeasured at each reporting date through the date of exercise or other settlement. The final measure of
compensation cost shall be the intrinsic value of the instrument at the date it is settled. Compensation cost
for each period until settlement shall be based on the change (or a portion of the change, depending on the
percentage of the requisite service that has been rendered for an employee award or the percentage that
would have been recognized had the grantor paid cash for the goods or services instead of paying with a
nonemployee award at the reporting date) in the intrinsic value of the instrument in each reporting period. The
entity shall continue to use the intrinsic value method for those instruments even if it subsequently concludes
that it is possible to reasonably estimate their fair value.
ASC 718-10-30-21 states, in part, that “in rare circumstances, it may not be possible to reasonably
estimate [the fair-value-based measure of a share-based payment award as of] the grant date because
of the complexity of its terms” (emphasis added). That is, there is a strong presumption under ASC 718
that the fair-value-based measure can be estimated unless there is substantial evidence to the contrary.
Paragraph B103 of FASB Statement 123(R) emphasizes this presumption by stating that, “[i]n light of the
variety of options and option-like instruments currently trading in external markets and the advances
in methods of estimating their fair values,” entities should be able to reasonably estimate the fair-value-
based measure of most awards as of the grant date. Accordingly, accounting for a share-based payment
award by using the intrinsic-value method under ASC 718-20-35-1 would be permitted only in the
unlikely event that there is substantial evidence indicating that it is not possible to reasonably estimate
the fair-value-based measure of the award.
186
4.12 Valuation of Nonpublic Entity Awards

ASC 718-10
Fair-Value-Based
ASC 718 identifies three ways for a nonpublic entity to measure share-based payment awards:
• By using fair value, which is the amount at which an asset (or liability) could be bought (or
incurred) or sold (or settled) in a current transaction between willing parties; that is, other than
in a forced or liquidation sale.
• By using a calculated value, which is a measure of the value of a stock option or similar
instrument determined by substituting the historical volatility of an appropriate industry sector
index for the expected volatility of a nonpublic entity’s share price in an option-pricing model.
See Section 4.13.2.
• By using intrinsic value, which is the amount by which the fair value of the underlying stock
exceeds the exercise price of an option or similar instrument. See Section 4.13.3.
Nonpublic entities should make an effort to value their equity-classified awards by using a fair-value-
based measure. A nonpublic entity may look to recent sales of its common stock directly to investors or
common stock transactions in secondary markets. However, observable market prices for a nonpublic
entity’s equity shares may not exist. In such an instance, a nonpublic entity could apply many of the
principles of ASC 820 to determine the fair value of its common stock, often by using either a market
approach or an income approach (or both). A “top-down method may be applied,” which involves first
valuing the entity, then subtracting the fair value of debt, and then using the resulting equity valuation
as a basis for allocating the equity value among the entity’s equity securities. While not authoritative, the
AICPA’s Accounting and Valuation Guide Valuation of Privately-Held-Company Equity Securities Issued as
Compensation (the AICPA Valuation Guide)4 emphasizes the importance of contemporaneous valuations
from independent valuation specialists to determine the fair value of equity securities.
4.12.1 Cheap Stock
The SEC often focuses on “cheap stock”5 issues in connection with a nonpublic entity’s preparation for an
IPO. The SEC staff is interested in the rationale for any difference between the fair value measurements
of the underlying common stock of share-based payment awards and the anticipated IPO price. In
addition, the SEC staff will challenge valuations that are significantly lower than prices paid by investors
to acquire similar stock. If the differences cannot be reconciled, a nonpublic entity may be required to
record a cheap-stock charge. Since share-based payments are often a compensation tool to attract and
retain employees or nonemployees, a cheap-stock charge could be material and, in some cases, lead to
a restatement of the financial statements.
An entity preparing for an IPO should refer to paragraph 7520.1 of the SEC Division of Corporation
Finance’s Financial Reporting Manual (FRM), which outlines considerations for registrants when the
“estimated fair value of the stock is substantially below the IPO price.” In such situations, registrants
should be able to reconcile the change in the estimated fair value of the underlying equity between
4
The AICPA Valuation Guide provides best-practice guidance for valuing the equity securities of nonpublic entities. It discusses, among other topics,
possible methods of allocating enterprise value to underlying securities, enterprise-and industry-specific attributes that should be considered in
the determination of fair value, best practices for supporting fair value, and recommended disclosures for a registration statement.
5
Cheap stock refers to issuances of equity securities before an IPO in which the value of the shares is below the IPO price.
187
the award grant date and the IPO by taking into account, among other things, intervening events and
changes in assumptions that support the change in fair value.
The SEC staff has frequently inquired about a registrant’s pre-IPO valuations. Specifically, during the
registration statement process, the SEC staff may ask an entity to (1) reconcile its recent fair values
with the anticipated IPO price, (2) describe its valuation methods, (3) justify its significant valuation
assumptions, (4) outline significant intervening events, and (5) discuss the weight it gives to stock
sale transactions. We encourage entities planning an IPO in the foreseeable future to use the AICPA
Valuation Guide6 and to consult with their valuation specialists. Further, they should ensure that their
pre-IPO valuations are appropriate and that they are prepared to respond to questions the SEC may
have during the registration statement process.
The AICPA Valuation Guide highlights differences between pre-IPO and post-IPO valuations. One
significant difference is that the valuation of nonpublic entity securities often includes a DLOM. The
DLOM can be determined by using several valuation techniques and is significantly affected by the
underlying volatility of the stock and the period the stock is illiquid.
The AICPA Valuation Guide describes three foundational methods for estimating the DLOM: the
protective put model, the Longstaff model, and the quantitative marketability discount model. However,
it is assumed under the Longstaff model that the investor is able to perfectly time the market and
therefore maximize proceeds. Since an investor typically does not have that timing ability, the Longstaff
model is generally not appropriate to use. In addition, use of the quantitative marketability discount
model may not be appropriate for complex capital structures or when it is assumed that there are long
holding periods.
While all put-based methods may have limitations, the protective put model, also known as the Chaffee
model or European7 protective put model, is widely used to calculate the DLOM. Entities perform the
calculation on the basis of an at-the-money put with a life equal to the period of restriction, divided by
the marketable stock value. The following are two commonly used variations of the protective put model:
• Finnerty model — Under this model, also known as the average-strike put option model, an entity
estimates the DLOM as an average-strike Asian8 put which measures the difference between the
average price over the holding period and the final price.
• Asian protective put model — Under this model, an entity estimates the DLOM as an average-
price Asian put that measures the difference between the current price and the average price
over the holding period. The Asian protective put model results in DLOMs that are lower than
those calculated under the protective put model and, for low volatility stocks, those calculated
under the Finnerty model. For high volatility stocks, it results in DLOMs that are higher than
those calculated under the Finnerty model.
4.12.2 ISOs, NQSOs, and Internal Revenue Code Section 409A

When granting share-based payment awards, a nonpublic entity should be mindful of the tax treatment
of such awards and the related implications. Section 409A of the Internal Revenue Code (IRC) contains
requirements related to nonqualified deferred compensation plans that can affect the taxability of
holders of share-based payment awards. If a nonqualified deferred compensation plan (e.g., one issued
in the form of share-based payments) fails to comply with certain IRC rules, the tax implications and
penalties at the federal level (and potentially the state level) can be significant for holders.
6
See footnote 4.
7
A European option can be exercised only on the expiration date.
8
An Asian option, or average option, is an option contract in which the payoff is based on the average price of the stock over a specific period (as
opposed to a single point).
188
Under U.S. tax law, stock option awards can generally be categorized into two groups:
• Statutory options, including incentive stock options (ISOs) and ESPPs that are qualified under IRC
Sections 422 and 423, respectively. The exercise of an ISO or a qualified ESPP does not result
in a tax deduction for the entity unless the employee or former employee makes a disqualifying
disposition. While an ISO may result in favorable tax treatment for the recipient, certain eligibility
conditions must be met.
• Nonstatutory options (also known as NQSOs or NSOs). The exercise of an NQSO results in a tax
deduction for the issuing entity that is equal to the intrinsic value of the option when exercised.
The ISOs and ESPPs described in IRC Sections 422 and 423, respectively, are specifically exempt from
the requirements of IRC Section 409A. Other NQSOs are outside the scope of IRC Section 409A if certain
requirements are met. One significant requirement is that the exercise price must not be below the
fair market value of the underlying stock as of the grant date. Accordingly, it is imperative to establish
a supportable fair market value of the stock to avoid unintended tax consequences for the issuer and
holder. While IRC Section 409A also applies to public entities, the valuation of share-based payment
awards for such entities is subject to less scrutiny because the market prices of the shares associated
with the awards are generally observable. Among other details, entities should understand (1) which
of their compensation plans and awards are subject to the provisions of IRC Section 409A and (2) how
they can ensure that those plans and awards remain compliant with IRC Section 409A and thereby avoid
unintended tax consequences of noncompliance.
A company’s failure to comply with the requirements in IRC Section 409A related to nonqualified
deferred compensation plans may affect how the fair value of existing and future share-based
compensation is determined and how those awards are taxed. Specifically, if the form and operation
of compensation arrangements do not comply with the requirements in IRC Section 409A, service
providers will be required to include the compensation in their taxable income sooner than they would
need to under general tax rules (e.g., vesting as opposed to exercise of an option) and service providers
will be subject to an additional 20 percent federal income tax plus interest on the amount included in
their taxable income. Although the tax is imposed on the individuals receiving the compensation, in
certain instances, an entity may decide to pay the additional tax liabilities on behalf of its employees.
Among IRC Section 409A’s many requirements, valuation of the stock on the grant date is critical, and
grantees should establish the fair market value of their shares to ensure compliance with IRC Section
409A. Both nonqualified and statutory options are subject to IRC Section 409A unless they otherwise
meet its criteria for treatment as exempt stock rights. It is important for an entity to consult with tax
advisers regarding the tax effects of both existing and planned share-based compensation plans to
determine whether it is subject to the requirements in IRC Section 409A or other IRC sections.
In addition, when recognizing compensation cost, many nonpublic entities use their IRC Section 409A
assessments to value their share-based payments. Because those assessments are used for tax
purposes, nonpublic entities should carefully consider whether they are also appropriate for measuring
share-based payment awards under ASC 718.
See Chapter 10 of Deloitte’s Roadmap Income Taxes for a discussion of the income tax effects of share-
based payments.
189
4.12.3 Purchases of Shares From Employees

4.12.3.1 Entity Purchases of Shares From Employees
ASC 718-20
Repurchase or Cancellation
35-7 The amount of cash or other assets transferred (or liabilities incurred) to repurchase an equity award
shall be charged to equity, to the extent that the amount paid does not exceed the fair value of the equity
instruments repurchased at the repurchase date. Any excess of the repurchase price over the fair value of
the instruments repurchased shall be recognized as additional compensation cost. An entity that repurchases
an award for which the promised goods have not been delivered or the service has not been rendered has,
in effect, modified the employee’s requisite service period or nonemployee’s vesting period to the period
for which goods have already been delivered or service already has been rendered, and thus the amount of
compensation cost measured at the grant date but not yet recognized shall be recognized at the repurchase
date.
To give their employees liquidity (or for other reasons), entities may sometimes repurchase vested
common stock from them. In some cases, the price paid for the shares exceeds their fair value at the
time of the transaction, and the excess would generally be recognized as additional compensation
cost in accordance with ASC 718-20-35-7. In addition, an entity’s practice of repurchasing shares, or an
arrangement that permits repurchase, could affect the classification of share-based payment awards.
See Sections 5.6 and 6.10 for additional discussion of how an entity’s past practice affects classification.
4.12.3.2 Investor Purchases of Shares From Grantees

ASC 718-10
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.
Economic Interest in an Entity

Any type or form of pecuniary interest or arrangement that an entity could issue or be a party to, including
equity securities; financial instruments with characteristics of equity, liabilities, or both; long-term debt and
other debt-financing arrangements; leases; and contractual arrangements such as management contracts,
service contracts, or intellectual property licenses.
On occasion, investors (such as private equity or venture capital investors) intending to increase
their stake in an emerging nonpublic entity may undertake transactions with other shareholders in
connection with or separately from a recent financing round. These transactions may include the
purchase of shares of common or preferred stock by investors from the founders of the nonpublic
entity or other individuals who are also considered employees. Because the transactions are between
employees of the nonpublic entity and existing shareholders and are related to the transfer of
outstanding shares, the nonpublic entity may not be directly involved in them (though it may be
190
indirectly involved by facilitating the exchange or not exercising a right of first refusal). Sometimes, if
there is sufficient evidence that a transaction is an arm’s-length, orderly fair value transaction, it may be
necessary to treat the transaction as a data point in the estimation of the fair-value-based measurement
of share-based payment awards. Other times, particularly when a transaction involves founders or a
few select key employees, it may be difficult to demonstrate that the transaction is not compensatory.
If the price paid for the shares exceeds their fair value at the time of the transaction, it is likely that the
nonpublic entity will be required to recognize compensation cost for the excess, even if the entity is not
directly involved in the transaction. It is important for a nonpublic entity to recognize that transactions
such as these may be subject to the guidance in ASC 718-10-15-4 because the investors are considered
holders of an economic interest in the entity.
Although the presumption in such transactions is that any consideration in excess of the fair value of
the shares is compensation paid to employees, entities should consider whether the amount paid is
related to an existing relationship or to an obligation that is unrelated to the employees’ services to the
entity in assessing whether the payment is “clearly for a purpose other than compensation for services
to the reporting entity.” Even though it is difficult to demonstrate that a non–fair value transaction with
employees is clearly for other purposes, AIN-APB 25 (superseded by FASB Statement 123(R)) describes
situations when doing so may be possible, including those in which:
• “[T]he relationship between the stockholder and the corporation’s employee is one which would
normally result in generosity (i.e., an immediate family relationship).”
• “[T]he stockholder has an obligation to the employee which is completely unrelated to the
latter’s employment (e.g., the stockholder transfers shares to the employee because of personal
business relationships in the past, unrelated to the present employment situation).”
In all situations, the determination of whether a transaction should be accounted for under ASC 718
should be based on an entity’s specific facts and circumstances.
In addition, there may be situations in which, as part of a financing transaction between a nonpublic
entity and a new investor that is acquiring a significant ownership interest in the nonpublic entity, the
new investor repurchases common shares in the nonpublic entity from employees of the nonpublic
entity. For example, the investor may not have participated in a prior financing arrangement and may be
purchasing convertible preferred stock from the nonpublic entity and common stock from the nonpublic
entity’s existing employees. In this scenario, the investor pays the same price to purchase the preferred
stock from the nonpublic entity and the common stock from the employees. While it did not hold an
economic interest before entering into the transaction with the nonpublic entity, the new investor is
not unlike a party that already holds such an interest and may be similarly motivated to compensate
employees.
As noted in ASC 718-10-15-4, a share-based payment arrangement between the holder of an economic
interest in a nonpublic entity and an employee of the nonpublic entity should be accounted for under
ASC 718 unless the arrangement “is clearly for a purpose other than compensation for goods or
services.” If a new investor purchases common stock valued at an amount based on the value of the
preferred stock, we would generally expect the analysis to be similar to that performed by a preexisting
investor that purchases common stock from a nonpublic entity’s employees.
191
4.12.3.2.1 Valuation Considerations
While the examples above describe situations in which it is likely that the nonpublic entity would
recognize additional compensation cost, we are aware of circumstances in which a secondary market
transaction between an investor and a nonpublic entity’s employees represents an orderly arm’s-length
transaction at fair value. In such cases, the nonpublic entity has adequate support for a conclusion that
the transaction was at fair value and therefore did not result in additional compensation cost. Often,
the stock repurchase is a secondary market transaction, the nonpublic entity does not enter into a
separate financing transaction concurrently, and the investor has not acquired a significant ownership
interest in the nonpublic entity. If the nonpublic entity can provide support for a conclusion that the
stock repurchase transaction was at fair value and was not compensatory, we would expect the entity
to take the transaction into account when valuing its common-stock, which a third-party valuation
firm typically performs to ensure compliance with IRC Section 409A and determine the fair-value-
based measure of the nonpublic entity’s share-based payment arrangements (see Section 4.12.2).
For this type of transaction, we would expect the nonpublic entity to consider both compensatory and
noncompensatory indicators when evaluating the substance of the transaction.
Upon concluding that a secondary market transaction is noncompensatory, a nonpublic entity should
consider the following guidance in paragraph 8.07 of the AICPA Valuation Guide9 to assess whether it
should factor the secondary market transaction into its IRC Section 409A fair value determination of its
common stock.
AICPA Valuation Guide
When evaluating secondary market transactions and their relevance for estimating fair value of the equity
securities within an enterprise, the [AICPA’s Equity Securities Task Force (the “task force”)] recommends
considering the following framework, which is consistent with guidance in FASB ASC 820:
If there is a transaction for an identical security on the measurement date and
• if the transaction takes place in an active market, then the task force believes the transaction price would
represent the fair value of the security.FN3
• if the evidence indicates that the transaction is orderly, then the task force believes that transaction price
should be taken into account. The amount of weight placed on that transaction price when compared
with other indications of fair value will depend on the facts and circumstances, including the volume of
the transaction.
• if the evidence indicates that the transaction is not orderly, then the task force believes little, if any,
weight should be placed on that transaction price.
• if the company does not have sufficient information to conclude whether a transaction is orderly, then
the task force believes it should take into account the transaction price (that is, give it some weight in the
analysis.)
Note that in [ASC 718 and ASC 505-50], restrictions that apply only during the vesting period are not considered in
FN3
assessing the fair value of the security; however, post-vesting restrictions may be considered.
9
See footnote 4.
192
AICPA Valuation Guide (continued)
The following flowchart shows these steps.
Is the
transaction for
an identical security on
the measurement
date?
Yes
Does the
Yes transaction take No
place in an active
market?
The transaction price would No Does the evidence

represent the fair value of the indicate the transaction
security. is orderly?
Yes
Yes Does the evidence No

indicate the transaction is
not orderly?
Take the transaction price into

Place little, if any, weight on
account. When determining how
that transaction price, and use
much weight to place on such
other approaches or methods
secondary market transactions,
for estimating fair value of the
consider factors discussed in
securities.
paragraphs 8.12–.13.
193
4.12.3.2.2 Tax Considerations
For tax purposes, stock repurchases are generally treated either as capital (e.g., capital gain) or as
dividend-equivalent redemptions (e.g., ordinary dividend income to the extent that the entity has
earnings and profits). Repurchases from current or former service providers (i.e., current or former
employees or independent contractors) give rise to questions about whether any of the proceeds
should be treated as compensation for tax purposes.
In the assessment of whether a portion of the payment is compensation, a critical tax issue is what value
is appropriate for the nonpublic entity to use when determining the effect of the capital redemption.
That is, the nonpublic entity must determine whether some portion of the consideration for the
repurchase represents something other than fair value for the common stock (e.g., compensation
cost). When a repurchase exceeds the fair value of the common stock, there is risk that some of the
purchase consideration is compensation for tax purposes. The determination of whether such excess
is compensatory depends on the facts and circumstances, and there can be disparate treatment for
book and tax purposes with respect to compensation transactions as well as ambiguity in the existing
tax code. Relevant factors include whether the repurchase is (1) performed by the nonpublic entity or an
existing investor or (2) part of arm’s-length negotiations with a new investor that may not have the same
information as the nonpublic entity about what is considered to be the fair market value of the stock.
If the purchaser is not the nonpublic entity, it is relevant whether the shares will be held by the buyer,
or whether they can be converted into a different class of stock or put back to the nonpublic entity.
Another factor is whether an offer to sell at a higher price is limited to service providers or is available to
shareholders more generally.
If the repurchase resulted in compensation for tax purposes, the nonpublic entity would include such
compensation on Form W-2 (for employees) or Form 1099-MISC (for independent contractors). While
any tax liability resulting from additional compensation is the obligation of the individual, the nonpublic
entity has an obligation to (1) withhold income and payroll taxes from payments to employees and
(2) remit the employer share of payroll tax. A nonpublic entity that does not withhold payroll taxes from
an employee in a transaction in which the excess purchase price is compensatory becomes responsible
for the tax and should evaluate whether to accrue a liability in accordance with the guidance in ASC 450.
That guidance addresses the proper accounting treatment of non-income-tax contingencies such as
sales and use taxes, property taxes, and payroll taxes.
An estimated loss contingency, such as a payroll tax liability, is accrued (i.e., expensed) if (1) it is probable
that the liability has been incurred as of the date of the financial statements and (2) the amount of the
liability is reasonably estimable. A loss contingency must be disclosed if (1) the loss is probable as of
the date of the financial statements or it is reasonably possible that the liability has been incurred and
(2) the amount is material to the financial statements.
With respect to a payroll tax liability, the liability recorded as a tax transaction should be the best
estimate of the probable amount due to the tax authority under the applicable law, which would include
interest and penalties. In addition, the nonpublic entity would need to evaluate whether it has any
arrangements in place with its employees that would make it responsible for its employees’ tax liability. If
the best estimate of the liability is a range, and if one amount in the range represents a better estimate
than any other amount in the range, that amount should be recorded in accordance with ASC 450-20-
30-1. If no amount in the range is a better estimate than any other amount, the minimum amount in the
range should be used to record the liability in accordance with ASC 450-20-30-1.
194
An entity has a legal right to seek reimbursement for the payroll tax liability (although not for income
tax withholding, penalties, or interest) from employees if the IRS makes a determination to seek the
withholdings from the entity. Accordingly, an entity could record an offsetting receivable from the
employees for the payroll tax withholdings. However, the entity will need to assess the collectability
of such a receivable, including whether the entity has sufficient evidence of an employee’s ability to
reimburse the entity for the payroll tax liability and whether the entity has the intent to collect this
liability from the employee.
The following is an example of a disclosure that an entity may make about its repurchase of common
stock from its employees when it has incurred a payroll tax liability as a result of not withholding payroll
taxes:
In connection with our Series A financing, we repurchased common shares from our employees. The
transaction was undertaken to provide liquidity to our employees and allows us to offer investors additional
Series A shares without further dilution of the existing shareholders. While we have viewed the transaction to
be a capital transaction for tax purposes, tax authorities could challenge this characterization and consider
a portion of the payment to be compensation to the employees, which would require us to remit payroll tax
withholdings to the tax authorities. For the probable amount of taxes and penalties that may be payable, the
Company has recorded a liability of $5 million, which represents the low end of the range of probable amounts
of payroll tax withholdings and penalties that would be payable. The ultimate payment amount could exceed
the liability recorded, and we estimate that the reasonably possible range of such payment could be up to $8
million.
Given the complexities of this type of transaction, including the evaluation of existing tax law, entities
should consult with their auditors and tax specialists when quantifying the liability under ASC 450.
Note that if a payment is considered compensation, a deduction of the same amount would also be
allowed (subject to all applicable rules related to deductions for compensation expense).
4.12.4 Interpolation Considerations for Valuing Share-Based Compensation

Early-stage companies often obtain independent valuations once per year. However, the dates of the
valuations do not always coincide with the grant date, or other relevant measurement date, for a share-
based payment award. As a result, management must assess the current fair value of the underlying
shares as of the measurement date.
Management should consider qualitative and quantitative factors when assessing the current fair value
of the underlying shares as of the measurement date if a current independent valuation is not readily
available. A current independent valuation could be based on a recent arm’s-length willing buyer, on
a willing seller transaction (an “orderly transaction”10), or on value indications under the income and
market approaches that are reconciled to a value estimate. The relevance of qualitative and quantitative
factors becomes greater as the period between the most recent valuation and the measurement date
increases.
We believe that when management performs its assessment of fair value, it should consider the factors
outlined in the AICPA Valuation Guide. However, those factors are not all-inclusive since an entity’s
specific circumstances may affect valuation. In the absence of an orderly transaction or of the data
needed for an entity to apply the income and market approaches, the entity should work with its auditor
and an independent valuation specialist to ensure that it has properly identified all relevant factors that
could affect the fair value of the underlying share price.
10
ASC 820 defines an orderly transaction as a “transaction that assumes exposure to the market for a period before the measurement date to allow
for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (for example,
a forced liquidation or distress sale).” In private-company financing transactions, the usual and customary marketing activities generally include
time for the investors to perform due diligence and to discuss the company’s plans with management, the board of directors, or both.
195
When evaluating the factors in the AICPA Valuation Guide, management should determine whether
there have been any positive or negative changes to the fair value of the underlying shares since the
most recent independent valuation. Accordingly, management may consider the following in making its
determination:
• Material changes in strategic relationships with major suppliers or customers — A loss or gain of
a major supplier or customer that was not factored into the previous valuation can materially
affect the entity. Changes in the financial health and profitability of strategic suppliers or
customers can also affect the entity’s valuation.
• Material changes in enterprise cost structure and financial condition — A change in the cost
structure flexibility (i.e., relationship between fixed and variability cost) may affect the entity’s
previous expectations regarding its cash burn rate and future financial strength.
• Material changes in the management team’s competence — A change in the experience and
competence of the management team may affect the entity’s future strategic objectives and
direction.
• Material changes in existing proprietary technology, products, or services — The nature of the
industry, patents, exclusive license arrangements, and enterprise-owned and developed
intellectual property may significantly affect an entity’s valuation. Entities that do not have
proprietary technology should evaluate whether there is a high likelihood of product
obsolescence.
• Material changes in workforce and workforce skills — The quality of the workforce as a result of
specialized knowledge or skills of key employees can be a significant input into certain entities’
valuation.
• Material change in the state of the industry and economy — Local, national, and global economic
conditions may adversely or positively affect an entity.
• Material third-party arm’s-length transactions in the entity’s equity— These types of transactions
11
may be indicators of fluctuation in the fair value of the underlying shares.
• Material changes in valuation assumptions used in the last valuation — The likelihood of the
occurrence of a liquidity event, such as an IPO or a merger or an acquisition, or significant
changes in the financial metrics or the valuations of the entity’s publicly traded comparable
companies.
Entities that grant equity between two independent valuations or after an independent valuation
should consider using an interpolation or extrapolation framework to estimate the fair value of the
underlying shares. Such frameworks may include linear interpretation, hockey stick interpolation, or the
consideration of equity granted after the most recent valuation (extrapolation). Entities should evaluate
the appropriateness of using an interpolation framework and should consider the factors outlined
above if they use such a framework.
The examples below illustrate circumstances in which the use of an interpolation framework may be
appropriate.
11
For additional information about considering secondary transactions, see Chapter 8 of the AICPA Valuation Guide.
196
Example 4-4A
Linear Interpolation
Company X performed an independent valuation of its common stock as of December 15, 20X8, and
September 18, 20X9. Company X’s common stock value increased from $1.50 to $2.25 between December
15, 20X8, and September 18, 20X9. On April 1, 20X9, X granted 500,000 options on its common stock to its
employees, with an exercise price of $1.50. Company X evaluated the qualitative and quantitative factors
discussed above and did not identify any significant events that occurred during this interim period that would
have caused a material change in fair value of the common stock. Further, over this period, management
monitored its industry and peer group multiples and observed that these valuation inputs did not suggest a
change in the fair value of X’s common stock.
We believe that in the absence of an orderly transaction or data necessary for an entity to apply the income
and market approaches, it is acceptable for management to perform a linear interpolation between the
December 15, 20X8, and September 18, 20X9, valuation dates to determine the fair value of the common stock
as of April 1, 20X9.
After performing a linear interpolation, X concluded that the fair value of the common stock as of April 1, 20X9,
was $1.79. When valuing the 500,000 options granted on April 1, 20X9, management would use $1.79 as the
fair value of the common stock. The graphic below illustrates X’s linear interpolation.
$2.50 September 18, 20X9,

April 1, 20X9,
valuation: $2.25
interpolation
$2.00 valuation: $1.79
Value of Common Stock
$1.50
December 15, 20X8,
valuation: $1.50
$1.00
$0.50 Linear Interpolation

April 1, 20X9, Grant Date
$0.00
9/30/20X8
10/1/2015 12/31/20X8
12/31/2015 3/31/20X9
3/31/2016 6/30/20X9
6/30/2016 9/30/20X9
9/29/2016 12/31/20X9
12/29/2016
Timeline
Example 4-4B
Hockey Stick Interpolation

Assume the same facts as in the example above; however, Company X’s operating results were higher than
originally forecasted in the December 15, 20X8, valuation model. Specifically, X performed above expectations
during the interim period July 1, 20X9, through September 18, 20X9. Its performance was primarily influenced
by higher than expected customer acquisitions and improved pricing. Before July 1, 20X9, management
evaluated the qualitative and quantitative factors discussed above and did not identify any significant events
that occurred before July 1, 20X9, that would have caused a material change in fair value of the common stock.
Management therefore concluded that the common stock valuation was flat during this period.
197
Example 4-4B (continued)
We believe that in the absence of an orderly transaction or of the data necessary for the application of the
income and market approaches, it is acceptable for management to perform a “hockey stick” interpolation
between the December 15, 20X8, and September 18, 20X9, valuation to determine the fair value of the
common stock as of April 1, 20X9. This is because management has evidence that the increase in the fair value
of the common stock was primarily attributable to better-than-expected growth from July 1, 20X9, through
September 18, 20X9. The graphic below illustrates X’s interpolation.
$2.50 September 18, 20X9,

valuation: $2.25
$2.00
Value of Common Stock
April 1, 20X9,
valuation: $1.50
$1.50
December 15, 20X8,
valuation: $1.50
$1.00
$0.50
Hockey Stick Interpolation
April 1, 20X9, Grant Date

$0.00
9/30/20X8
10/1/2015 12/31/20X8
12/31/2015 3/31/20X9
3/31/2016 6/30/20X9
6/30/2016 9/30/20X9
9/29/2016 12/31/20X9
12/29/2016
Timeline
As suggested in the graphic above, X concluded that the fair value of the common stock as of April 1, 20X9, was
$1.50. However, if management had granted options on its common stock between July 20X9 and September
20X9, management would use the interpolation framework above to determine the fair value of the common
stock.
Example 4-4C
Equity Granted After the Most Recent Valuation (Extrapolation)

After performing an independent valuation of its common stock as of July 1, 20X9, Company Y, which has a
calendar year-end, concluded that the fair value of the common stock was $2.00. On December 1, 20X9, Y
granted 500,000 options that can be exercised on Y’s common stock. On March 1, 20X0, Y will issue its financial
statements without having an updated independent valuation of its common stock (i.e., it will only have the July
1, 20X9, valuation).
Company Y is generating revenue but is currently operating at a loss. At the time of Y’s July 1, 20X9, common
stock valuation, management forecasted FYX9 revenue of $10 million and FYX0 revenue of $25 million. As of
December 1, 20X9, management revaluated its actual and forecasted revenue and concluded that there were
no material changes to its original revenue forecast. Management considered the qualitative and quantitative
factors discussed above in determining whether the common stock fair value had changed. On the basis of its
assessment as well as its unchanged revenue forecast, management concluded that the common stock fair
value had remained flat and that there was no evidence that the fair value of the common stock had materially
increased or decreased since the July 1, 20X9, valuation. As a result, when valuing the options granted on
December 1, 20X9, management used $2.00 as the fair value of the common stock.
198
Assume the same facts as those above; however, revenue for fiscal year 20X9 and forecasted fiscal
year 20X0 is 10 percent above the July 1, 20X9, amount forecasted in the previous valuation. In this
scenario, management should develop a reasonable method to reflect an increase in the fair value of
the common stock between July 1, 20X9, and December 1, 20X9. For example, on the basis of Y’s July 1,
20X9, valuation, management can approximate the incremental impact on its common stock as a result
of the revenue increase in fiscal years 20X9 and 20X0. Using this amount as a benchmark, management
could approximate the fair value of the common stock as of December 1, 20X9.
See Deloitte’s March 17, 2017, Financial Reporting Alert for a discussion of disclosure considerations.
4.13 Practical Expedients for Nonpublic Entities

4.13.1 Application
There are several practical expedients in ASC 718 that are available only to nonpublic entities. To apply
them, an entity will need to first ensure that it meets the definition of a nonpublic entity as defined in
ASC 718 (see Section 1.7).
Changing Lanes
In October 2021, the FASB issued ASU 2021-07, which allows nonpublic entities to use, as a
practical expedient, “the reasonable application of a reasonable valuation method” to determine
the current price input of equity-classified share-based payment awards issued to both
employees and nonemployees. The ASU notes that a valuation performed in accordance with
specified U.S. Treasury regulations related to IRC Section 409A is an example of a reasonable
valuation method under the practical expedient. The ASU also explicitly refers to other valuation
approaches under IRC Section 409A that are presumed to be reasonable.
As discussed in Sections 4.13.2 and 4.13.3, there are other practical expedients available to
nonpublic entities under ASC 718 related to the use of the calculated value and intrinsic value.
In SAB Topic 14.B, the SEC provides transition guidance for entities that elect those practical
expedients and are changing from nonpublic to public entity status (see Section 4.13.4).
However, there is no similar transition guidance in ASU 2021-07 on the use of the practical
expedient. Therefore, an entity that no longer meets the criteria to be a nonpublic entity
would have to reverse the practical expedient’s effect in its historical financial statements.
Consequently, before electing the practical expedient in ASU 2021-07, nonpublic entities that
could become public entities should carefully consider the potential future costs of having to
perform such a reversal.
See Deloitte’s October 26, 2021, Heads Up for additional information about the ASU, including its
effective dates.
199
4.13.1.1 Fair-Value-Based Measurement Exceptions

Two alternatives to fair-value-based measurement are available to nonpublic entities:
• Calculated value — A nonpublic entity that cannot reasonably estimate the fair-value-based
measure of its options and similar instruments (because it is not practicable to estimate the
expected volatility of its stock price) should use the historical volatility of an appropriate industry
sector index to calculate an award’s value. This amount is referred to as a calculated value.
See Section 4.13.2 for a discussion of a nonpublic entity’s use of the historical volatility of an
appropriate industry sector index in valuing a share-based payment award.
• Intrinsic value — For liability-classified awards, nonpublic entities can elect as an accounting
policy to measure all of their liability-classified awards at either intrinsic value or a fair-value-
based measure. See Section 4.13.3 for additional information.
The table below summarizes the use of these measurement alternatives.
Public Entities Nonpublic Entities
Equity-classified awards Fair-value-based measure Either:
• Fair-value-based measure*
• Calculated value**
Liability-classified awards Fair-value-based measure, Either:

remeasured in each reporting
period until settlement • Fair-value-based measure* (or a calculated
value**), remeasured in each reporting
period until settlement
• Intrinsic value, remeasured in each
reporting period until settlement
* Expected volatility is based on the entity’s own share price or comparable public entities.
** Expected volatility is based on the historical volatility of an appropriate industry sector index; a calculated value is used
when it is not practicable to estimate the expected volatility of an entity’s own share price.
4.13.1.2 Expected-Term Practical Expedient

A nonpublic entity may make an entity-wide accounting policy election to use a practical expedient to
estimate the expected term of certain options and similar instruments. The practical expedient can be
used only for awards that meet certain conditions. See Section 4.9.2.2.3 for additional information.
4.13.2 Calculated Value
ASC 718-10
Nonpublic Entity — Calculated Value for Nonemployee Awards

30-19A 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
200
Nonpublic Entity — Calculated Value

30-20 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
718-10-55-51 through 55-58 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.
Calculated Value for Certain Nonpublic Entities

55-51 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).
55-52 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 718-10-30-19A through 30-20 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 718-10-30-21 through
30-22 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.
55-53 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 718-10-55-35 through 55-41.
55-54 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.
55-55 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 718-10-55-4 through 55-47.
201
55-56 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.
55-57 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.
55-58 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.
As discussed in Section 4.12, nonpublic entities should try to use a fair-value-based measure to value
their equity-classified awards. However, there may be instances in which a nonpublic entity may not
be able to reasonably estimate the fair-value-based measure of its options and similar instruments
because it is not practicable for it to estimate the expected volatility of its share price. In these cases, the
nonpublic entity should substitute the historical volatility of an appropriate industry sector index for the
expected volatility of its own share price. In assessing whether it is practicable to estimate the expected
volatility of its own share price, the entity should consider the following factors:
• Whether the entity has an internal market for its shares (e.g., investors or employees can
purchase and sell shares).
• Previous issuances of equity in a private transaction or convertible debt provide indications of

the historical or implied volatility of the entity’s share price.
• Whether there are similarly sized public entities (including those within an index) in the same
industry whose historical or implied volatilities could be used as a substitute for the nonpublic
entity’s expected volatility.
If, after considering the relevant factors, the nonpublic entity determines that estimating the expected
volatility of its own share price is not practicable, it should use the historical volatility of an appropriate
industry sector index as a substitute in estimating the fair-value-based measure of its awards.
202
An appropriate industry sector index would be one that is narrow enough to reflect the nonpublic
entity’s nature and size (if possible). For example, the use of the Philadelphia Exchange (PHLX)
Semiconductor Sector Index is not an appropriate industry sector index for a small nonpublic software
development entity because it represents neither the industry in which the nonpublic entity operates
nor the size of the entity. The volatility of an index of smaller software entities would be a more
appropriate substitute for the entity’s expected volatility of its own share price.
Under ASC 718-10-55-58, an entity that uses an industry sector index to determine the expected
volatility of its own share price must use the index’s historical volatility (rather than its implied volatility).
However, ASC 718-10-55-56 states that “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” (emphasis added).
A nonpublic entity’s conclusion that estimating the expected volatility of its own share price is not
practicable may be subject to scrutiny. We would typically expect that a nonpublic entity that can identify
an appropriate industry sector index would be able to identify similar entities from the selected index to
estimate the expected volatility of its own share price and would therefore be required to use the fair-
value-based measurement method.
In measuring awards, a nonpublic entity should switch from using a calculated value to using a fair-
value-based measure when it (1) can subsequently estimate the expected volatility of its own share price
or (2) becomes a public entity. ASC 718-10-55-27 states, in part, that the “valuation technique an entity
selects [should] be used consistently and [should] not be changed unless a different valuation technique
is expected to produce a better estimate” of a fair-value-based measure (or, in this case, a change
to a fair-value-based measure). The guidance goes on to state that a change in valuation technique
should be accounted for as a change in accounting estimate under ASC 250 and should be applied
prospectively to new awards. Therefore, for existing equity-classified awards (i.e., unvested equity
awards that were granted before an entity switched from the calculated value method to a fair-value-
based measure), an entity would continue to recognize compensation cost on the basis of the calculated
value determined as of the grant date unless the award is subsequently modified. An entity should use
the fair-value-based method to measure all awards granted after it switches from the calculated value
method.
ASC 718 provides the example below of when it may be appropriate for a nonpublic entity to use the
calculated value method.
ASC 718-20
Example 9: Share Award Granted by a Nonpublic Entity That Uses the Calculated Value Method
55-76 This Example illustrates the guidance in paragraphs 718-10-30-19A through 30-20.
cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, an
entity should substitute the historical volatility of an appropriate industry sector index for expected volatility in
accordance with paragraph 718-10-30-20 when measuring the grant-date fair value of nonemployee awards
with similar facts and circumstances (that is, an entity has determined that it is not practicable for it to estimate
the expected volatility of its share price), as illustrated in paragraphs 718-20-55-77 through 55-80. Therefore,
203
55-76B Compensation cost attribution for awards to nonemployees may be the same as or different from
that which is illustrated in paragraph 718-20-55-81 for employee awards. 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 this Example 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 payment transactions.
55-77 On January 1, 20X6, Entity W, a small nonpublic entity that develops, manufactures, and distributes
medical equipment, grants 100 share options to each of its 100 employees. The share price at the grant date is
$7. The options are granted at-the-money, cliff vest at the end of 3 years, and have a 10-year contractual term.
Entity W estimates the expected term of the share options granted as 5 years and the risk-free rate as 3.75
percent. For simplicity, this Example assumes that no forfeitures occur during the vesting period and that no
dividends are expected to be paid in the future, and this Example does not reflect the accounting for income
tax consequences of the awards.
55-78 Entity W does not maintain an internal market for its shares, which are rarely traded privately. It has not
issued any new equity or convertible debt instruments for several years and has been unable to identify any
similar entities that are public. Entity W has determined that it is not practicable for it to estimate the expected
volatility of its share price and, therefore, it is not possible for it to reasonably estimate the grant-date fair value
of the share options. Accordingly, Entity W is required to apply the provisions of paragraph 718-10-30-20 in
accounting for the share options under the calculated value method.
55-79 Entity W operates exclusively in the medical equipment industry. It visits the Dow Jones Indexes website
and, using the Industry Classification Benchmark, reviews the various industry sector components of the Dow
Jones U.S. Total Market Index. It identifies the medical equipment subsector, within the health care equipment
and services sector, as the most appropriate industry sector in relation to its operations. It reviews the current
components of the medical equipment index and notes that, based on the most recent assessment of its share
price and its issued share capital, in terms of size it would rank among entities in the index with a small market
capitalization (or small-cap entities). Entity W selects the small-cap version of the medical equipment index as
an appropriate industry sector index because it considers that index to be representative of its size and the
industry sector in which it operates. Entity W obtains the historical daily closing total return values of the selected
index for the five years immediately before January 1, 20X6, from the Dow Jones Indexes website. It calculates
the annualized historical volatility of those values to be 24 percent, based on 252 trading days per year.
55-80 Entity W uses the inputs that it has determined above in a Black-Scholes-Merton option-pricing formula,
which produces a value of $2.05 per share option. This results in total compensation cost of $20,500 (10,000 ×
$2.05) to be accounted for over the requisite service period of 3 years.
55-81 For each of the 3 years ending December 31, 20X6, 20X7, and 20X8, Entity W will recognize
compensation cost of $6,833 ($20,500 ÷ 3). The journal entry for each year is as follows.

204
55-82 The share option award granted by a nonpublic entity that used the calculated value method is as follows.
Share Option Award Granted by a Nonpublic Entity That Uses the Calculated Value Method
Cumulative
Year Total Calculated Value of Award Pretax Cost for Year Pretax Cost
20X6 $20,500 (10,000 × $2.05) $6,833 ($20,500 ÷ 3) $ 6,833
20X7 $20,500 (10,000 × $2.05) $6,834 ($20,500 × 2/3 – $6,833) $ 13,667
20X8 $20,500 (10,000 × $2.05) $6,833 ($20,500 – $13,667) $ 20,500
55-83 Assuming that all 10,000 share options are exercised on the same day in 20Y2, the accounting for the
option exercise will follow the same pattern as in Example 1, Case A (see paragraph 718-20-55-10) and will
result in the following journal entry.
At exercise the journal entry is as follows.
Cash (10,000 × $7) $70,000

Common stock $90,500
To recognize the issuance of shares upon exercise of options and to
reclassify previously recognized paid-in capital.
4.13.3 Intrinsic Value
ASC 718-30
Nonpublic Entity
30-2 A nonpublic entity shall make a policy decision of whether to measure all of its liabilities incurred under
share-based payment arrangements (for employee and nonemployee awards) issued in exchange for distinct
goods or services at fair value or at intrinsic value. However, a nonpublic entity shall initially and subsequently
measure awards determined to be consideration payable to a customer (as described in paragraph 606-10-
32-25) at fair value.
Nonpublic Entity
35-4 Regardless of the measurement method initially selected under paragraph 718-10-30-20, a nonpublic
entity shall remeasure its liabilities under share-based payment arrangements at each reporting date until the
date of settlement. The fair-value-based method is preferable for purposes of justifying a change in accounting
principle under Topic 250. Example 1 (see paragraph 718-30-55-1) provides an illustration of accounting for an
instrument classified as a liability using the fair-value-based method. Example 2 (see paragraph 718-30-55-12)
provides an illustration of accounting for an instrument classified as a liability using the intrinsic value method.
A nonpublic entity shall subsequently measure awards determined to be consideration payable to a customer
(as described in paragraph 606-10-32-25) at fair value.
Nonpublic entities can make a policy election to measure all liability-classified awards (not including
awards determined to be consideration payable to a customer) at intrinsic value (instead of at their
fair-value-based measure or calculated value) as of the end of each reporting period until the award is
settled. However, it is preferable for an entity to use the fair-value-based method to justify a change in
accounting principle under ASC 250 (see Section 4.13.4 for a discussion of how to record the effects
205
of the change when a nonpublic entity becomes a public entity). Therefore, a nonpublic entity that has
elected to measure its liability-classified awards at a fair-value-based measure (or calculated value)
would not be permitted to subsequently change to the intrinsic-value method.
The example below illustrates the application of the intrinsic value method for liability-classified awards
granted by a nonpublic entity.
ASC 718-30
Example 2: Award Granted by a Nonpublic Entity That Elects the Intrinsic Value Method
55-12 This Example illustrates the guidance in paragraphs 718-30-35-4 and 718-740-25-2 through 25-4.
cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, a
nonpublic entity can make the accounting policy election in paragraph 718-30-30-2 to change its measurement
of all liability-classified nonemployee awards from fair value to intrinsic value and remeasure those awards
each reporting period as illustrated in this Example. Therefore, the guidance in this Example may serve as
implementation guidance for similar liability-classified nonemployee awards.
55-12B Compensation cost attribution for awards to nonemployees may be the same or different for
liability-classified employee awards. 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 this Example 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 payment transactions.
55-13 On January 1, 20X6, Entity W, a nonpublic entity that has chosen the accounting policy of using the
intrinsic value method of accounting for share-based payments that are classified as liabilities in accordance
with paragraphs 718-30-30-2 and 718-30-35-4, grants 100 cash-settled stock appreciation rights with a 5-year
life to each of its 100 employees. Each stock appreciation right entitles the holder to receive an amount in
cash equal to the increase in value of 1 share of Entity W’s stock over $7. The awards cliff-vest at the end
of three years of service (an explicit and requisite service period of three years). For simplicity, the Example
assumes that no forfeitures occur during the vesting period and does not reflect the accounting for income tax
consequences of the awards.
55-14 Because of Entity W’s accounting policy decision to use intrinsic value, all of its share-based payments
that are classified as liabilities are recognized at intrinsic value (or a portion thereof, depending on the
percentage of requisite service that has been rendered) at each reporting date through the date of settlement;
consequently, the compensation cost recognized in each year of the three-year requisite service period will
vary based on changes in the liability award’s intrinsic value. As of December 31, 20X6, Entity W stock is valued
at $10 per share; hence, the intrinsic value is $3 per stock appreciation right ($10 – $7), and the intrinsic value
of the award is $30,000 (10,000 × $3). The compensation cost to be recognized for 20X6 is $10,000 ($30,000
÷ 3), which corresponds to the service provided in 20X6 (1 year of the 3-year service period). For convenience,
this Example assumes that journal entries to account for the award are performed at year-end. The journal
entry for 20X6 is as follows.

Share-based compensation liability $10,000
206
55-15 As of December 31, 20X7, Entity W stock is valued at $8 per share; hence, the intrinsic value is $1 per
stock appreciation right ($8 – $7), and the intrinsic value of the award is $10,000 (10,000 × $1). The decrease
in the intrinsic value of the award is $20,000 ($10,000 – $30,000). Because services for 2 years of the 3-year
service period have been rendered, Entity W must recognize cumulative compensation cost for two-thirds of
the intrinsic value of the award, or $6,667 ($10,000 × 2/3); however, Entity W recognized compensation cost of
$10,000 in 20X5. Thus, Entity W must recognize an entry in 20X7 to reduce cumulative compensation cost to
$6,667.

To adjust cumulative compensation cost ($6,667 – $10,000).
stock appreciation right ($15 – $7), and the intrinsic value of the award is $80,000 (10,000 × $8). The cumulative
compensation cost recognized as of December 31, 20X8, is $80,000 because the award is fully vested. The
journal entry for 20X8 is as follows.

To recognize compensation cost ($80,000 – $6,667).
55-17 The share-based liability award at intrinsic value is as follows.
Cumulative
Year Total Value of Award at Year-End Pretax Cost for Year Pretax Cost
20X6 $30,000 (10,000 × $3) $10,000 ($30,000 ÷ 3) $ 10,000
20X7 $10,000 (10,000 × $1) $(3,333) [($10,000 × 2/3) – $10,000] $ 6,667
20X8 $80,000 (10,000 × $8) $73,333 ($80,000 – $6,667) $ 80,000
55-18 For simplicity, this Example assumes that all of the stock appreciation rights are settled on the day that
they vest, December 31, 20X8, when the share price is $15 and the intrinsic value is $8 per share. The cash paid
to settle the stock appreciation rights is equal to the share-based compensation liability of $80,000.
55-19 At exercise the journal entry is as follows.

Cash (10,000 × $8) $80,000
To recognize the cash payment to employees for settlement of stock
appreciation rights.
55-20 If the stock appreciation rights had not been settled, Entity W would continue to remeasure those
remaining awards at intrinsic value at each reporting date through the date they are exercised or otherwise
settled.
207
4.13.4 Transition From Nonpublic to Public Entity Status

SAB Topic 14.B, Transition From Nonpublic to Public Entity Status [Excerpt; Reproduced in ASC 718-10-S99-1]
Facts: Company A is a nonpublic entity8 that first files a registration statement with the SEC to register its
equity securities for sale in a public market on January 2, 20X8.9 As a nonpublic entity, Company A had been
assigning value to its share options10 under the calculated value method prescribed by FASB ASC Topic 718,
Compensation — Stock Compensation,11 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.
Question 1: How should Company A account for the share options that were granted to its employees 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.12 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.13
8
Defined in the FASB ASC Master Glossary.
9
For the purposes of these illustrations, assume all of Company A’s equity-based awards granted to its employees were
granted after the adoption of FASB ASC Topic 718.
10
For purposes of this staff accounting bulletin, the phrase “share options” is used to refer to “share options or similar
instruments.”
11
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).
12
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.
13
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.
208
Question 2: How should Company A account for its liability awards granted to its employees prior to January 2,
20X8 which 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.14 When Company A becomes a public entity, it should measure the
liability awards at their fair value determined in accordance with FASB ASC Topic 718.15 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 $5.16
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 granted to the Company’s employees. 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.17
Question 4: Upon becoming a public entity, what disclosures should Company A consider in addition to those
prescribed by FASB ASC Topic 718?18
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.19 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 applicability of SEC Release No. FR-6020 and Section V, “Critical Accounting Estimates,” in SEC
Release No. FR-7221 regarding critical accounting policies and estimates in MD&A.

14

15
$15 fair value less $10 intrinsic value equals $5 of incremental cost.
16
This view is consistent with the FASB’s basis for rejecting full retrospective application of FASB ASC Topic 718 as described
17
in the basis for conclusions of Statement 123R, paragraph B251.

18
See generally SEC Release No. FR-72, “Commission Guidance Regarding Management’s Discussion and Analysis of
19
Financial Condition and Results of Operations.”

SEC Release No. FR-60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies.”
20
SEC Release No. FR-72, “Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition
21
and Results of Operations.”
The measurement alternatives available to a nonpublic entity (calculated value and intrinsic value) are
no longer appropriate once the entity is considered a public entity.12 In addition, the expected-term
practical expedient to determine the expected term of certain options and similar instruments is used
differently by public entities and nonpublic entities. To estimate the expected term as a midpoint
between the requisite service period and the contractual term of an award, entities will need to comply
with the requirements of the SEC’s simplified method (see Section 4.9.2.2.2).
12
The definition of a “public entity” in ASC 718 includes an entity that “[m]akes a filing with a regulatory agency in preparation for the sale of any class
of equity securities in a public market.” The definition therefore includes an entity that has filed its initial registration statement with the SEC before
the effective date of an IPO.
209
In SAB Topic 14.B, the SEC discusses various transition issues associated with valuing share-based
payment awards related to an entity’s becoming public (e.g., when it files its initial registration statement
with the SEC), including the following:
• If a nonpublic entity historically measured equity-classified share-based payment awards at their

calculated value, the newly public entity should continue to use that approach for share-based
payment awards granted before the date it becomes a public entity unless those awards are
subsequently modified, repurchased, or canceled.
• If a nonpublic entity historically measured liability-classified share-based payment awards on the

basis of their intrinsic value and the awards are still outstanding, the newly public entity should
measure those liability awards at their fair-value-based measurement upon becoming a public
entity.
• Upon becoming a public entity, the entity is prohibited from retrospectively applying the fair-
value-based measurement to its awards if it used calculated value or intrinsic value before the
date it became a public entity.
• Upon becoming a public entity, the entity should clearly describe in its MD&A the change in
accounting policy that will be required by ASC 718 in subsequent periods and any reasonably
likely material future effects of the change.
The SEC’s guidance does not address how an entity should account for a change from the intrinsic
value method for measuring liability-classified awards to the fair-value-based method. In informal
discussions, the SEC staff indicated that it would be acceptable to record the effect of such a change
as compensation cost in the current period or to record it as the cumulative effect of a change in
accounting principle in accordance with ASC 250. While the preferred approach is to treat the effect of
the change as a change in accounting principle under ASC 250, with the cumulative effect of the change
recorded accordingly, recording it as compensation cost is not objectionable given the SEC’s position.
Under either approach, entities’ financial statements should include the appropriate disclosures.
ASC 250-10-45-5 states, in part, that an “entity shall report a change in accounting principle through
retrospective application of the new accounting principle to all prior periods, unless it is impracticable
to do so.” Retrospective application of the effects of a change from intrinsic value to fair value would
be impracticable because objectively determining the assumptions an entity would have used for the
prior periods would be difficult without the use of hindsight. Therefore, the change would be recorded
as a cumulative-effect adjustment to retained earnings and applied prospectively, as discussed in ASC
250-10-45-6 and 45-7. This conclusion is consistent with the guidance in SAB Topic 14.B that states
that entities changing from nonpublic to public status are not permitted to apply the fair-value-based
method retrospectively.
210
The example below illustrates how to record the effects of a change from the intrinsic value method to
the fair-value-based method.
Example 4-5
Company A (with a calendar year-end) uses the intrinsic value method to account for its liability-classified SARs,
which are fully vested on December 31, 20X6. On February 15, 20X7, A files its initial registration statement with
the SEC for an IPO. Assume the following intrinsic values and fair values:
Intrinsic Value Fair Value
December 31, 20X6 $5 N/A
February 15, 20X7 $8 $10
In its financial statements included in the initial registration statement, A should use the intrinsic value method
to account for the SARs. As a result of filing its initial registration statement with the SEC, A must change its
method for valuing its SARs from the intrinsic value method to the fair-value-based method. For the period
from January 1, 20X7, through February 15, 20X7, A should therefore record compensation cost of $3 under
the intrinsic value method and should record $2 as either an adjustment to retained earnings or compensation
cost to account for the change from the intrinsic value method to the fair-value-based method.
211
Chapter 5 — Classification
5.1 General
ASC 718-10
Determining Whether to Classify a Financial Instrument as a Liability or as Equity

25-6 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.
An entity’s measurement of compensation cost for awards within the scope of ASC 718 differs
depending on whether the entity determines that the awards are classified as equity or liabilities (i.e.,
a fair-value-based measure as of the grant date for most equity-classified awards versus a fair-value-
based measure as of the end of each reporting period until settlement for liability-classified awards). The
classification of share-based payment awards can be complex. While classifying a cash-settled award as
a liability may seem straightforward, entities must consider the features and conditions of every award.
Generally, the following types of awards (with certain exceptions, including those noted below) must be
classified as liabilities in accordance with ASC 718-10-25-6 through 25-19A:
Types of Awards Discussion Exceptions
Awards that would be Although share-based payment awards In determining the classification of share-
classified as liabilities subject to ASC 718 are outside the scope based payment awards under ASC 480,
under ASC 480 of ASC 480, ASC 718-10-25-7 requires an entities should take into account the
entity to apply the classification criteria scope exceptions related to ASC 480, as
in ASC 480-10-25 and in ASC 480-10- discussed in ASC 718-10-25-8 and Section
15-3 and 15-4 unless ASC 718-10-25-8 5.2.1, as well as any specific exceptions in
through 25-19A require otherwise. See ASC 718-10-25-8 through 25-19A.
ASC 718-10-25-7 and 25-8 and Section
5.2 for a discussion of how to apply the
classification criteria in ASC 480 to share-
based payment awards.
Stock awards subject ASC 718-10-25-9 and 25-10 distinguish ASC 718-10-25-9(a) does not require
to repurchase between repurchase features that are liability classification for contingent
features that do not within the control of the issuer and those repurchase features that are not within
subject the grantee that are not within the control of the the grantee’s control and it is not probable
to the risks and issuer. See Section 5.3 for guidance on that the contingency will occur. In addition,
rewards of equity determining the classification of callable ASC 718-10-25-18 exempts from liability
share ownership for a and puttable stock awards. classification, under certain circumstances,
reasonable period repurchases that are used to satisfy the
employer’s statutory tax withholding
requirements. See Section 5.7.2.
212
(Table continued)
Types of Awards Discussion Exceptions
Stock options or ASC 718-10-25-11 and 25-12 require that ASC 718-10-25-11(b) does not require
similar instruments stock options or similar instruments be liability classification for contingent cash
for which (1) the classified as a liability if the (1) underlying settlement features that are not within the
underlying shares are shares are classified as a liability or (2) the grantee’s control and it is not probable that
classified as liabilities options or similar instruments must be the contingency will occur. ASC 718-10-
or (2) the options or settled in cash or the grantee can require 25-16 and 25-17 exempt from liability
similar instruments the entity to settle in cash. See Section classification, under certain circumstances,
can be required to 5.4 for guidance on determining the broker-assisted cashless exercises. In
be settled in cash or classification of stock options for which addition, ASC 718-10-25-18 exempts
other assets cash settlement could be required. from liability classification, under certain
circumstances, repurchases of shares upon
option exercises that are used to satisfy
the employer’s statutory tax withholding
requirements. See Section 5.7.2.
Awards with Under ASC 718-10-25-13, awards indexed ASC 718-10-25-14 and 25-14A exempt
conditions or other to something other than a market, stock options with a fixed exercise price in
features that are performance, or service condition must be a foreign currency awarded to a grantee
indexed to something classified as a liability. See Section 5.5 for of a foreign operation from liability
other than a market, a discussion of other conditions. classification provided that the exercise
performance, or price is denominated in (1) the foreign
service condition operation’s functional currency, (2) the
currency in which the foreign operation’s
employees are paid, or (3) the currency of
a market in which a substantial portion of
the entity’s equity securities trades.
Awards that are ASC 718-10-25-15 states that to ASC 718-10-25-15(a) states that a
substantive liabilities determine an award’s classification, requirement to deliver registered shares
because (1) the an entity should evaluate the award’s does not imply, by itself, that an entity
grantee has the substantive terms as well as the entity’s does not have the ability to settle the
choice of settlement past practices and its ability to settle in award in shares.
in cash or shares shares. See Section 5.6 for a discussion
or (2) the entity can of factors that an entity with a choice
choose the method of settlement method may consider in
of settlement but determining an award’s classification.
does not have the
intent, past practice,
or ability to settle with
shares
Certain awards that Other applicable GAAP (e.g., ASC 815) Under ASC 718-10-35-9 through 35-14,
may become subject may apply to awards that are originally certain freestanding instruments issued
to other applicable accounted for as share-based payment to grantees may never become subject to
GAAP awards under ASC 718 but are modified other GAAP. In addition, an award would
after a grantee (1) whose awards are not be subject to other GAAP if the award
vested is no longer providing goods or is modified (after a grantee whose awards
services, (2) whose awards are vested is are vested is no longer providing goods
no longer a customer, or (3) is no longer or services, after a grantee whose awards
an employee. In addition, once vested, are vested is no longer a customer, or
a convertible instrument award granted the grantee is no longer an employee)
to a nonemployee becomes subject to solely to reflect an equity restructuring
other applicable GAAP. See ASC 718-10- that meets certain conditions under ASC
35-9 through 35-14 in Section 5.8 as well 718-10-35-10A.
as Section 9.5 for a discussion of when
share-based payment awards subject
to ASC 718 become subject to other
applicable GAAP.
213
5.2 ASC 480
ASC 718-10
25-7 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 480-10-15-3 through 15-4 in determining whether to classify
as a liability a freestanding financial instrument given to a grantee in a share-based payment transaction.
Paragraphs 718-10-35-9 through 35-14 provide criteria for determining when instruments subject to this Topic
subsequently become subject to Topic 480 or to other applicable GAAP.
25-8 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 718-10-25-11 through 25-12.
ASC 480-10
Mandatorily Redeemable Financial Instruments

25-4 A mandatorily redeemable financial instrument shall be classified as a liability unless the redemption is
required to occur only upon the liquidation or termination of the reporting entity.
25-5 A financial instrument that embodies a conditional obligation to redeem the instrument by transferring
assets upon an event not certain to occur becomes mandatorily redeemable if that event occurs, the condition
is resolved, or the event becomes certain to occur.
25-6 In determining if an instrument is mandatorily redeemable, all terms within a redeemable instrument
shall be considered. The following items do not affect the classification of a mandatorily redeemable financial
instrument as a liability:
a. A term extension option
b. A provision that defers redemption until a specified liquidity level is reached
c. A similar provision that may delay or accelerate the timing of a mandatory redemption.
25-7 If a financial instrument will be redeemed only upon the occurrence of a conditional event, redemption
of that instrument is conditional and, therefore, the instrument does not meet the definition of mandatorily
redeemable financial instrument in this Subtopic. However, that financial instrument would be assessed at
each reporting period to determine whether circumstances have changed such that the instrument now meets
the definition of a mandatorily redeemable instrument (that is, the event is no longer conditional). If the event
has occurred, the condition is resolved, or the event has become certain to occur, the financial instrument is
reclassified as a liability.
Obligations to Repurchase Issuer’s Equity Shares by Transferring Assets

25-8 An entity shall classify as a liability (or an asset in some circumstances) any financial instrument, other than
an outstanding share, that, at inception, has both of the following characteristics:
a. It embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such an obligation.
b. It requires or may require the issuer to settle the obligation by transferring assets.
214
25-9 In this Subtopic, indexed to is used interchangeably with based on variations in the fair value of. The phrase
requires or may require encompasses instruments that either conditionally or unconditionally obligate the issuer
to transfer assets. If the obligation is conditional, the number of conditions leading up to the transfer of assets
is irrelevant.
25-10 Examples of financial instruments that meet the criteria in paragraph 480-10-25-8 include forward
purchase contracts or written put options on the issuer’s equity shares that are to be physically settled or net
cash settled.
25-11 All obligations that permit the holder to require the issuer to transfer assets result in liabilities, regardless
of whether the settlement alternatives have the potential to differ.
25-12 Certain financial instruments that embody obligations that are liabilities within the scope of this Subtopic
also may contain characteristics of assets but be reported as single items. Some examples include the
following:
a. Net-cash-settled or net-share-settled forward purchase contracts
b. Certain combined options to repurchase the issuer’s shares.
Those instruments are classified as assets or liabilities initially or subsequently depending on the instrument’s
fair value on the reporting date.
25-13 An instrument that requires the issuer to settle its obligation by issuing another instrument (for example,
a note payable in cash) ultimately requires settlement by a transfer of assets, accordingly:
a. When applying paragraphs 480-10-25-8 through 25-12, this also would apply for an instrument settled
with another instrument that ultimately may require settlement by a transfer of assets (warrants for
puttable shares).
b. It is clear that a warrant for mandatorily redeemable shares would be a liability under this Subtopic.
Certain Obligations to Issue a Variable Number of Shares

25-14 A financial instrument that embodies an unconditional obligation, or a financial instrument other than
an outstanding share that embodies a conditional obligation, that the issuer must or may settle by issuing a
variable number of its equity shares shall be classified as a liability (or an asset in some circumstances) if, at
inception, the monetary value of the obligation is based solely or predominantly on any one of the following:
a. A fixed monetary amount known at inception (for example, a payable settleable with a variable number
of the issuer’s equity shares)
b. Variations in something other than the fair value of the issuer’s equity shares (for example, a financial
instrument indexed to the Standard and Poor’s S&P 500 Index and settleable with a variable number of
the issuer’s equity shares)
c. Variations inversely related to changes in the fair value of the issuer’s equity shares (for example, a
written put option that could be net share settled). . . .
Although share-based payment awards subject to ASC 718 are outside the scope of ASC 480, ASC
718-10-25-7 requires entities to apply the classification criteria in ASC 480-10-25 and in ASC 480-10-
15-3 and 15-4 unless ASC 718-10-25-8 through 25-19A require otherwise. Under ASC 480-10-25 and
ASC 480-10-15-3 and 15-4, liability classification is required if an award meets any of the criteria in the
table below. In addition, ASC 718-10-25-8 clarifies that the scope exceptions in ASC 480 for certain
mandatorily redeemable financial instruments also apply to share-based payment awards within the
scope of ASC 718. See Section 5.2.1 for more information.
215
Examples of Share-Based
ASC 480 Instruments Payment Awards Comments
Mandatorily redeemable financial • An entity issues to a grantee The repurchase or redemption

instruments described in ASC common stock or restricted feature must be unconditional
480-10-25-4 through 25-7, and shares that must be (i.e., the entity and grantee cannot
defined in the ASC master glossary repurchased by the entity as choose the method of settlement).
as “financial instruments issued in of specified or determinable In addition, no other features of the
the form of shares that embody dates (e.g., upon the employee’s instrument’s terms can exist that
an unconditional obligation death or any termination would cause the shares not to be
requiring the issuer to redeem event). redeemed. For example, preferred
the instrument by transferring
its assets at a specified or
• An entity issues to a grantee shares that may be converted
into common shares before the
redeemable preferred stock
determinable date (or dates) or that must be repurchased as of specified redemption date(s) would
upon an event that is certain to specified or determinable dates. not result in liability classification
occur.” for the preferred shares if the
• If an entity offers a deferred
conversion feature is substantive.
compensation plan to
employees under which an ASC 480 includes a scope exception
employee is forced into a for certain mandatorily redeemable
diversified account (i.e., a rabbi financial instruments of nonpublic
trust), such a plan would most entities and certain mandatorily
likely be considered mandatorily redeemable noncontrolling
redeemable in accordance with interests of all entities (public and
ASC 480 (see Section 2.7). nonpublic). See Section 5.2.1.
A financial instrument, other • An entity issues to a grantee a The guidance in ASC 480 only
than an outstanding share, that freestanding written put option applies if the repurchase feature
embodies (or is indexed to) an to sell the entity’s shares back is considered “freestanding” (e.g.,
obligation to repurchase shares to it at a fixed price. a legally detachable written put
(conditionally or unconditionally) by
transferring cash or other assets
• An entity enters into a forward option). Most share repurchase
features are embedded and not
contract to repurchase shares
as described in ASC 480-10-25-8 of its common stock from a legally detachable.
through 25-13. grantee on a specified date in
Under ASC 718, the following
the future at a fixed price.
exceptions apply to certain awards
with repurchase features that
would otherwise be classified as
liabilities under ASC 480:
• ASC 718-10-25-11 and 25-12

provide explicit guidance on
the impact of repurchase
and cash settlement features
contained in options or
similar instruments issued
to grantees that include
conditions that permit equity
classification (see Section
5.3).
• ASC 718-10-25-18 contains
an exception to liability
classification for awards
that are net settled to meet
the employer’s statutory
withholding requirements
resulting from the grantee’s
exercise of an option share
(see Section 5.7.2).
216
(Table continued)
Examples of Share-Based
ASC 480 Instruments Payment Awards Comments
A financial instrument that • An entity grants a bonus to its Awards that are based on monetary
embodies certain obligations chief executive for services to values at inception unrelated to
to issue a variable number of be rendered over the next two increases in the fair value of an
shares when the obligation’s years. The obligation will be entity’s equity and settled in a
monetary value is based, solely or settled by issuing to the grantee variable number of shares will most
predominantly, on any one of the a variable number of the entity’s likely result in share-settled debt
following items described in ASC shares valued at $100,000 on arrangements, accounted for as
480-10-25-14: the basis of the entity’s share share-based liabilities.
price at the end of the second
• “A fixed monetary amount year (see Example 2-2).
known at inception.”
• ESPPs that require the
• “Variations in something employee to purchase a specific
other than the fair value of dollar amount of the employer’s
the issuer’s equity shares.” stock on the purchase date; the
• “Variations inversely related amount of compensation cost is
to changes in the fair value fixed and known on the service
of the issuer’s equity shares.” inception date (see Section 8.3).
In accordance with ASC 480-10-25-14, an entity must classify a share-based payment award as a liability
if the award requires the entity to issue a variable number of shares when the obligation’s monetary
value is fixed. An obligation of this nature does not expose the grantee to the risks and rewards of a
typical equity ownership in an entity because the monetary value of the award is not indexed to the fair
value of the underlying shares that will be provided upon settlement. In the examples below, the entity’s
obligation related to awards granted to employees would meet the criteria under ASC 480-10-25-14 and
thus liability classification would be required.
Example 5-1
Variations in Something Other Than the Fair Value of the Issuer’s Equity Shares
Entity A grants employee stock options with an exercise price established on the grant date equal to a
fixed multiple of its trailing 12 months EBITDA. It is assumed that the EBITDA multiple does not represent a
reasonable approximation of the fair value of A’s equity shares. The settlement price of the options as of the
vesting date is also established according to a fixed multiple of the same trailing 12 months EBITDA of A. Any
excess of the options’ settlement price as of the vesting date over the options’ exercise price as of the grant
date is paid to the employees in a variable number of A’s shares on the basis of the fair value of A’s shares on
the vesting date. Because the monetary value of the options (1) is indexed solely to variations in an operating
performance measure of A (i.e., EBITDA) and (2) will be settled in a variable number of A’s shares, the options
will be classified as a share-based liability.
217
Example 5-1A
Settlement in a Variable Number of Shares on the Basis of a Fixed Monetary Amount

Entity B is a real estate brokerage firm that has a network of real estate agents who are employees. Upon hiring
an agent as an employee, B and the employee enter into a share-based payment arrangement. The terms of
the agreement specify that upon the closing of the employee’s first real estate sale, B will issue to the employee
shares of common stock equal to $1,000 on the basis of the fair value of B’s common stock as of the date of
the closing. The agent will vest in the award at the end of the second year of service following the date of the
closing (cliff vesting). Because B has granted an award for a fixed monetary amount to be settled in a variable
number of shares, the award is initially classified as a liability. Once the number of shares of common stock
to be issued under the award is fixed (upon the closing of the employee’s first real estate), and as long as all
criteria for equity classification are met, the award would be reclassified as equity.
5.2.1 ASC 480 Scope Exceptions That Apply to Share-Based Payments Within

the Scope of ASC 718
In determining the classification of share-based payment awards under ASC 480, nonpublic entities
should consider the scope exceptions related to ASC 480 described in ASC 718-10-25-8. The exceptions
apply to certain mandatorily redeemable financial instruments that either represent noncontrolling
interests or are issued by nonpublic entities that are not SEC registrants. For example, the classification
guidance in ASC 480 does not apply to mandatorily redeemable financial instruments of nonpublic
entities that are not SEC registrants unless they are mandatorily redeemable on fixed dates for amounts
that are either fixed or are determined by reference to an external index (e.g., an interest rate index or
currency index).
In addition, if a mandatorily redeemable financial instrument qualifies for one of the exceptions in
ASC 480-10, the issuer should consider the applicability of ASC 480-10-S99-3A to that instrument.
See Section 5.10 for a discussion and examples of the application of ASR 268 and ASC 480-10-S99-3A
to certain redeemable securities. For detailed guidance on the application of ASC 480, see Deloitte’s
Roadmap Distinguishing Liabilities From Equity.
5.3 Share Repurchase Features

ASC 718-10
25-9 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.
218
25-10 A puttable (or callable) share that does not meet either of those conditions shall be classified as equity
(see paragraph 718-10-55-85).
Classification of Certain Awards With Repurchase Features

55-84 The following paragraph further explains the guidance in paragraphs 718-10-25-9 through 25-12.
55-85 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 stock award (e.g., restricted stock) may include repurchase features on the underlying shares (e.g.,
puttable and callable shares). The type of an award’s repurchase features can affect its classification. Call
options and put options are the most common types of repurchase features. A call option repurchase
feature allows (but does not require) the entity to repurchase vested shares held by a grantee. A put
option repurchase feature allows (but does not require) the grantee to cause the entity to repurchase
vested shares that the grantee holds. The repurchase price associated with call and put options can
vary (e.g., fair value, fixed amount, cost, formula value). In addition, the ability to exercise a repurchase
feature is often contingent on certain events (e.g., termination of employment, change in control). A
right of first refusal, which gives the grantor the ability to repurchase shares from the grantee before the
grantee sells the shares to a third party, is an example of a contingent call option.
To determine the classification of a stock award (i.e., as liability or equity), an entity must understand the
terms of the repurchase features associated with it. The flowcharts and discussion throughout this section
are intended to help an entity determine how such features affect the classification of awards. They apply
only to stock awards subject to ASC 718 that contain conditional features (e.g., call or put options) to
transfer cash or other assets at settlement. This section therefore does not apply to the following awards:
• Stock awards subject to ASC 718 that contain unconditional obligations to transfer cash or
other assets. These awards are generally classified as share-based liabilities under ASC 718-10-
25-7. See Section 5.2 for a discussion of applying the classification criteria in ASC 480 to share-
based payment awards.
219
• Stock options or similar instruments that have cash settlement or repurchase features subject
to ASC 718. These awards are generally classified in accordance with ASC 718-10-25-11 and
25-12. See Section 5.4 for a discussion of the steps to follow in determining the classification of
stock options with cash settlement or repurchase features. However, because ASC 718-10-25-11
requires liability classification for options and similar instruments if the underlying shares are
classified as liabilities, ASC 718-10-25-9 and 25-10 apply to stock options or similar instruments
in which the underlying shares are puttable or callable. Accordingly, an entity would apply the
guidance in this section to determine the classification of those types of stock options or similar
instruments. In addition, while grantees generally begin to bear the risks and rewards of share
ownership when stock awards vest, they do not do so when stock options vest. Rather, grantees
begin to bear the risks and rewards of share ownership when the stock options are exercised
and the underlying shares are issued or issuable.
The determination of whether the grantee bears the risks and rewards normally associated with equity
share ownership for a reasonable period is based on whether the repurchase feature is at fair value
upon repurchase. If the repurchase feature is at fair value, the grantee bears the risks and rewards of
equity share ownership by holding the shares (upon vesting for stock awards and upon exercise for
stock option awards) for six months or more. If the repurchase feature is not at fair value, the grantee
may not bear the risks and rewards of equity share ownership as long as the repurchase feature is
outstanding, and the six-month period does not apply. As a result, many non–fair value repurchase
features result in an award’s classification as a liability. However, the classification analysis will also
depend on whether the repurchase feature is exercisable upon a contingent event, as further discussed
below.
Much of the guidance below is based on analogies to Issue 23 of EITF Issue 00-23. While EITF Issue
00-23 was superseded by ASC 718 (previously issued as FASB Statement 123(R)), some of the
superseded guidance is still relevant in the determination of whether a grantee bears the risks and
rewards of equity share ownership (provided that it is consistent with ASC 718-10-25-9 and 25-10).
220
Step 1
Step 2
Does the grantee’s
repurchase feature (i.e., put Is it probable that the
option) permit the grantee to grantor, through its repurchase
avoid bearing the risks and rewards feature (i.e., call option), would
normally associated with equity share No prevent the grantee from bearing the risks No
ownership for a reasonable period (six and rewards of equity share ownership
or more months) after the date the for a reasonable period (six or more
goods are delivered or services months) after the share is vested
are rendered and the share is and issued or issuable?
issued or issuable?
See Section 5.3.2.
See Section 5.3.1.
Yes
Yes
Classify the stock award as a share-based

Step 3
liability. For employee awards, if the
If the stock award contains
repurchase feature is solely related to
a put option, is classification
an employer’s statutory tax withholding as temporary (or mezzanine) equity
requirement, equity classification may be required under SAB Topic 14.E? All SEC
appropriate. Yes registrants should apply this step.
(Non-SEC registrants may elect
See Section 5.7.2. not to apply this step.)
See Section 5.10.
No
Classify the stock award outside

of permanent equity as temporary Classify the stock award as
(or mezzanine) equity. permanent equity.
5.3.1 Repurchase Features — Puttable Stock Awards
Is the
put option
exercisable only
No upon the occurrence Yes Contingently puttable stock
Noncontingent puttable stock
of a contingent event (e.g., award (see Section 5.3.1.2).
award (see Section 5.3.1.1).
involuntary termination of
employment, change
in control)?
To appropriately classify a stock award with a put option, an entity must first determine whether the
put option’s exercisability is contingent on the occurrence of an event. If the contingent event is solely
within the control of the grantee (e.g., voluntary termination), the repurchase feature should be analyzed
as if it is noncontingent. Noncontingent puttable shares are generally classified as liabilities unless
the put option is at fair value and cannot be exercised for at least six months after the shares have
vested. Contingently puttable shares may require liability classification depending, in part, on whether
the contingent event is solely within the grantee’s control. See the next section and Section 5.3.1.2 for
discussions of how such noncontingent puttable shares and contingently puttable shares, respectively,
should be evaluated under ASC 718-10-25-9(a).
221
If the put option does not result in liability classification, SEC registrants must consider the requirements
of ASR 268 (FRR Section 211) and ASC 480-10-S99-3A, as discussed in SAB Topic 14.E. In accordance with
that guidance, SEC registrants must present as temporary (or mezzanine) equity stock awards (otherwise
classified as equity) that are subject to redemption features that are not solely within the control of
the issuer. Temporary-equity classification is required if the puttable stock awards qualify for equity
classification under the requirements of ASC 718 (e.g., a stock award that is puttable at fair value by the
grantee more than six months after vesting). Puttable stock awards classified as temporary equity should
be recognized at their redemption value. See Section 5.10 for discussion and examples of the application
of ASR 268 and ASC 480-10-S99-3A to share-based payment awards with repurchase features.
5.3.1.1 Repurchase Features — Noncontingent Puttable Stock Awards
Is the
noncontingent
put option
Is the repurchase price Yes exercisable less than six
at fair value upon
months after the award has
repurchase?1
vested and the shares
are issued or
issuable?
Yes No
No
The stock award is classified as a

Additional analysis is required, liability until the shares are issued
but the stock award is generally The stock award is classified as
or issuable for six months. After six
classified as a liability until the equity.
months, any unsettled stock award is
repurchase feature expires. reclassified to equity.
Liability classification is required if the noncontingent put option permits the grantee to avoid bearing
the risks and rewards normally associated with share ownership for a reasonable period from the date
on which the stock award is vested and the shares are issued or issuable. If the repurchase price is
measured at fair value upon repurchase, to avoid liability classification, a grantee must bear the risks
and rewards of share ownership for at least a period of six months from the date the stock award is
vested and the shares are issued or issuable. A noncontingent put option (the exercise of which is in the
grantee’s control) that allows the grantee to exercise the put option within six months of the vesting
of the stock award results in liability classification of the stock award, even if the grantee is unlikely to
exercise the put option during that period. If the grantee holds the shares for six months, the shares
become “mature” and are reclassified to equity. If the noncontingent put option cannot be exercised
within six months of vesting, the put option would not cause the stock award to be classified as a liability.
If the repurchase price is not measured at fair value as of the repurchase date (e.g., repurchase at a
formula price), the grantee may not be subject to the risks and rewards of share ownership for as long
as the put option is outstanding, regardless of whether the repurchase feature can only be exercised six
months after the stock award vests. Therefore, if the repurchase price is not measured at fair value, the
stock award (or some portion of the award) will generally be classified as a liability until the put option
expires or is settled.
1
If the repurchase feature is at fair value, the employee bears the risks and rewards of equity share ownership by holding the shares for six months
or more after the shares are issued or issuable (i.e., the shares become “mature”). If the repurchase feature is not at fair value, the employee may
not bear the risks and rewards of equity share ownership as long as the repurchase feature is outstanding.
222
An exception to this requirement is a repurchase feature that enables entities to satisfy their statutory
tax withholding requirements (see Example 5-3). See ASC 718-10-25-18 and Section 5.7.2 for a
discussion of the effect of statutory tax withholding amounts on the classification of share-based
payment awards.
Entities must continually assess their stock awards to ensure that they are appropriately classified.
Awards that are initially classified as liability awards may subsequently be classified as equity awards if,
for example, the repurchase feature expires or, for fair value repurchase features, the shares are held
for at least six months from the date the stock awards vested (i.e., the shares are no longer immature).
The examples below illustrate noncontingent put options commonly found in share-based payment
arrangements.
Example 5-2
Repurchase at Fair Value

Entity A grants 1,000 shares of restricted stock to an employee that vest at the end of the second year of
service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares at their
then-current fair value 12 months from the date the stock awards are fully vested.
The repurchase feature will not result in liability classification of the stock awards since the employee is
required to bear the risks and rewards of share ownership for more than 6 months (i.e., 12 months) after the
stock awards have vested. However, if A is an SEC registrant, it must apply the requirements in ASR 268 and
ASC 480-10-S99-3A.
Example 5-3
Repurchase at Fair Value — Statutory Tax Withholding Requirements

service (cliff vesting). When the awards vest, the employee can require A to repurchase a portion of its shares at
their then-current fair value to meet A’s statutory tax withholding requirements.
The repurchase feature will not result in liability classification of the stock awards under ASC 718-10-
25-18 as long as the employee cannot require A to repurchase its shares in an amount that exceeds the
maximum statutory tax rate(s) in its applicable jurisdiction(s) and A has a statutory tax withholding requirement.
A repurchase feature giving the employee the right to require the repurchase of shares in excess of the
maximum statutory tax rate(s) in its applicable jurisdiction(s) or in circumstances in which A does not have a
statutory tax withholding requirement as of the vesting date will result in liability classification for the
entire award.
223
Example 5-4
Repurchase at a Fixed Price

service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares at a fixed
amount 12 months from the date the stock awards are fully vested.
The repurchase feature will result in liability classification of the stock awards since the employee is not
subject to the risks and rewards of share ownership for as long as the repurchase feature is outstanding,
regardless of whether the repurchase feature can only be exercised more than six months after the shares
vest. That is, the repurchase price is fixed at the inception of the arrangement and is therefore not measured at
fair value. The stock award would generally be accounted for as an award with a liability and equity component
in a manner similar to a combination award, as described in ASC 718-10-55-120 through 55-130. The liability
component is based on the fixed amount for which the employee can require A to repurchase its shares, and
the equity component is recognized as a call option with an exercise price equal to the fixed amount for which
the employee can require A to repurchase its shares. If the fixed-price repurchase feature expires, the liability
component is reclassified to equity.
Example 5-5
Repurchase at a Fixed Amount Over Fair Value

service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares 12
months from the date the stock awards are fully vested. The repurchase amount will be based on the fair value
of A’s shares on the date the employee exercises the put option plus $100 per share.
The repurchase feature will not result in liability classification of the stock awards for the portion of the
awards subject to the repurchase feature at fair value since the employee is required to bear the risks and
rewards of share ownership for more than 6 months (i.e., 12 months) after the stock awards have vested.
However, if A is an SEC registrant, it must apply the requirements in ASR 268 and ASC 480-10-S99-3A. In
addition, ASC 718-20-35-7 and ASC 718-10-55-85 require the recognition of additional compensation cost
for the excess of the repurchase price over the fair-value-based measure of an award (i.e., $100 per share).
The additional compensation cost is recognized over the requisite service period of the stock awards (i.e., two
years), with a corresponding amount recognized as a liability.
Example 5-6
Repurchase at a Formula Price

service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares 12
months from the date the stock awards are fully vested. The repurchase amount will be based on a multiple of
A’s earnings.
The repurchase feature will result in liability classification of the stock awards if the repurchase amount
is not measured at fair value; therefore, the employee would not be subject to the risks and rewards of share
ownership regardless of whether the repurchase feature can only be exercised more than six months after the
shares vest. Entity A will recognize the liability at its fair-value-based measure by using the formula price as of
each reporting period.
224
5.3.1.2 Repurchase Features — Contingently Puttable Stock Awards
Does the grantee solely No Is the repurchase price at fair

control the contingent event
value upon repurchase?2
(e.g., voluntary termination)?
Yes
Yes No
Treat as a noncontingent puttable
stock award (see Section 5.3.1.1).
Is it
probable that
Is it probable that
the contingent event
will occur (making the
put exercisable) less than six
put exercisable) while the
repurchase feature is
outstanding?
are issued or
issuable?
Yes No No Yes
The stock award is classified as a Additional analysis is required,

liability until the shares are issued but the stock award is generally
The stock award is classified as
or issuable for six months. After classified as a liability until the
equity.
six months, any unsettled stock repurchase feature expires.
award is reclassified to equity.
An entity should analyze a put option that becomes exercisable only upon the occurrence of a specified
future event (i.e., the triggering event) to determine whether the triggering event is solely within the
control of the grantee (i.e., the party that can exercise the put option). An entity should disregard
triggering events solely within the control of the grantee and analyze the repurchase feature as if it
is noncontingent (i.e., as if the triggering event already occurred) to determine whether it permits
the grantee to avoid bearing the risks and rewards normally associated with share ownership for a
reasonable period from the date the stock award is vested and the share is issued or issuable. See
Section 5.3.1.1 for a discussion of the effect of noncontingent repurchase features on the classification
of puttable stock awards.
2
The probability analysis for a fair value repurchase feature is performed for the six-month “window” that the shares are “immature” (i.e., within
six months of vesting). For a non–fair value repurchase feature, the analysis is performed for the entire period that the repurchase feature is
outstanding. The analysis is generally performed on a grantee-by-grantee basis and must be updated continually.
225
If the triggering event is not solely within the control of the grantee, the entity should assess, on an
individual-grantee basis, the probability that the triggering event will occur. Liability classification is
required for stock awards with fair value repurchase features if (1) it is probable that the triggering event
will occur within six months of the date the stock awards vest and (2) the repurchase feature will permit
the grantee to avoid bearing the risks and rewards normally associated with share ownership for six or
more months after the date the stock award is vested and the shares are issued or issuable. In addition,
liability classification is generally required for stock awards with non–fair value repurchase features if
(1) it is probable that the triggering event will occur while the repurchase feature is outstanding and
(2) the repurchase feature will permit the grantee to avoid bearing the risks and rewards normally
associated with share ownership while the repurchase feature is outstanding.
Equity classification is appropriate for stock awards with fair value repurchase features in which
occurrence of the triggering event is (1) not solely within the control of the grantee and (2) not probable
or only probable after the grantee has been subject to the risks and rewards normally associated with
share ownership for six or more months from the date the stock award is vested and the shares are
issued or issuable. If repurchase features are not measured at fair value, equity classification would
generally only be appropriate for stock awards in which occurrence of the triggering event is (1) not
solely within the control of the grantee and (2) not probable while the repurchase feature is outstanding.
Common triggering events for employee awards include:
Events not solely within

Events solely within the Events solely within the
the employee’s or
employee’s control entity’s control
the entity’s control
• Voluntary termination • Involuntary termination • Termination with cause

without cause
• Early retirement (when • Death
eligible)
• Disability
• Change in control
Awards that are initially classified as equity awards may be subsequently classified as liability awards
as a result of a change in probability assessment. Likewise, awards that are initially classified as liability
awards may subsequently be classified as equity awards if, for example, there is a change in probability
assessment, the repurchase feature expires, or, for fair value repurchase features, the shares are held
for at least six months from the date the stock awards vested (i.e., the shares are no longer immature).
Example 5-7
service (cliff vesting). The stock awards give the employee the right to require A to buy back its shares once a
change in control occurs. The repurchase amount will be based on the fair value of A’s shares on the date the
employee exercises the put option.
The repurchase feature will not result in liability classification of the stock awards but may result in
liability classification when it becomes probable that a change in control will occur. As discussed in Section
3.4.2.1, it is generally not considered probable that a change in control will occur until the change in control is
consummated.
If the change in control occurs six months after the stock awards vest, equity classification will remain
appropriate since the employee would have been subject to the risks and rewards normally associated with
share ownership for at least a period of six months from the date the stock awards vested. However, if A is an
SEC registrant, it must apply the requirements in ASR 268 and ASC 480-10-S99-3A.
226
5.3.2 Repurchase Features — Callable Stock Awards
Is the call
option only
exercisable upon the
No occurrence of a contingent Yes Contingently callable stock
Noncontingent callable stock
award (see Section 5.3.2.1). event (e.g., involuntary award (see Section 5.3.2.2).
termination of
employment, change
in control)?
In a manner similar to its treatment of a put option, an entity that grants a stock award with a call option
must, to appropriately classify it, first determine whether the call option’s exercisability is contingent on
the occurrence of a triggering event. However, unlike contingently puttable shares, all contingent events
are assessed for probability, irrespective of whether the triggering event is solely within the grantee’s
control. See Sections 5.3.2.1 and 5.3.2.2 for a discussion of how such noncontingent callable shares and
contingently callable shares, respectively, should be evaluated under ASC 718-10-25-9(b).
Unlike put options, call options that do not result in liability classification are not assessed by SEC
registrants in accordance with the requirements of ASR 268 and ASC 480-10-S99-3A because the
redemption feature is solely within the control of the issuer, and that guidance applies only to awards
with redemption features not solely within the control of the issuer. That is, a stock award with terms
that only permit the entity to repurchase the shares will never be classified as temporary equity.
227
5.3.2.1 Repurchase Features — Noncontingent Callable Stock Awards
Is the repurchase price at fair

Yes No
Is it probable that
the call option will Is it probable that the
be exercised less than six call option will be exercised
months after the award has while the repurchase feature is
vested and the shares are outstanding?
issued or issuable?
Yes No No Yes
The stock award is classified as a liability Additional analysis is required,

until the shares are issued or issuable for six but the stock award is generally
The stock award is classified as
months. After six months (or after exercise is classified as a liability until the
equity.
no longer probable if earlier), any unsettled repurchase feature expires.
stock award is reclassified to equity.
ASC 718-10-25-9(b) requires liability classification of stock awards when (1) the entity has the ability to
call the shares upon the vesting of the award (i.e., the call option is noncontingent) and (2) it is probable
that the call option will be exercised before the grantee has been subject to the risks and rewards
normally associated with share ownership for a reasonable period from the date the stock award is
vested and the shares are issued or issuable. The requirement to assess probability is different from
the requirement in ASC 718-10-25-9(a). That guidance does not permit an assessment of the grantee’s
probability of exercising a noncontingent put option. That is, a repurchase feature allowing grantees
to exercise a noncontingent put option within six months of the vesting of the stock awards will always
result in liability classification of the stock award, even if the grantee is unlikely to exercise the put
option.
The probability assessment in ASC 718-10-25-9(b) should be based on (1) the entity’s stated
representations that it has the positive intent not to call the shares while they are immature (i.e., within
six months of vesting for fair value repurchase features and while the call option is outstanding for non–
fair value repurchase features) and (2) all other relevant facts and circumstances. In assessing all other
3
See footnote 2.
228
relevant facts and circumstances, the entity may analogize to the guidance in superseded Issue 23(a) of
EITF Issue 00-23, which indicates that an entity should consider the following additional factors:
• “The frequency with which the [grantor] has called immature shares in the past.”
• “The circumstances under which the [grantor] has called immature shares in the past.”
• “The existence of any legal, regulatory, or contractual limitations on the [grantor’s] ability to
repurchase shares.”
• “Whether the [grantor] is a closely held, private company.”

If the repurchase price is measured at fair value upon repurchase, to avoid liability classification, a
grantee must bear the risks and rewards of share ownership for at least a period of six months from
the date the stock award is vested and the shares are issued or issuable. A noncontingent call option
(the exercise of which is in the entity’s control) that allows the entity to exercise the call option within
six months of the vesting of the stock award results in liability classification of the stock award if it is
probable that the entity will exercise the call option within those six months. If it is not probable that the
entity will exercise the call option within those six months, the call option will not cause the stock award
to be classified as a liability. In addition, if the noncontingent call option cannot be exercised within six
months of vesting, the call option would not cause the stock award to be classified as a liability, and a
probability assessment is not required.
An exception to liability classification is a repurchase feature that enables entities to satisfy their
statutory tax withholding requirements (see Example 5-3). See ASC 718-10-25-18 and Section 5.7.2
for a discussion of the effect of statutory tax withholding amounts on the classification of share-based
payment awards.
If the repurchase price is not measured at fair value on the repurchase date (e.g., repurchase at a
formula price), the grantee may not be subject to the risks and rewards of share ownership for as long
as the call option is outstanding, regardless of whether the repurchase feature can only be exercised
more than six months after the stock award vests. Therefore, the probability assessment should be
performed for all periods for which the repurchase feature is outstanding. If the repurchase price is not
measured at fair value, the stock award will generally be classified as a liability if it is probable that the
entity will exercise the call option while the call option is outstanding. If it is not probable that the entity
will exercise the call option while the call option is outstanding, the call option will not cause the stock
award to be classified as a liability. An exception to liability classification can be applied if the repurchase
price is at a fixed amount over the fair value on the repurchase date. In this case, if it is not probable that
the call option will be exercised for at least six months from the date the stock awards vest but it is still
probable that the call option will be exercised while the repurchase feature is outstanding, only the fixed
amount in excess of fair value would be classified as a liability award. Further, it is generally probable
that a noncontingent call feature that allows the entity to repurchase shares at a price that is below
fair value or potentially below fair value on the repurchase date will be exercised irrespective of
the holding period. However, the entity should evaluate the repurchase provision to determine whether,
in substance, it represents a vesting condition or clawback feature (see Section 5.3.4 for further
discussion).
Awards may initially be classified as equity awards but, as a result of a change in the probability
assessment, may subsequently be classified as liability awards. Likewise, awards that are initially
classified as liability awards may subsequently be classified as equity awards if, for example, (1) there is a
change in the probability assessment, (2) the repurchase feature expires, or (3) for fair value repurchase
features, the shares are held for at least six months from the date the stock awards vested (i.e., the
shares are no longer immature).
229
Example 5-8
service (cliff vesting). The employee is restricted from selling A’s shares to a third party for 12 months after they
vest. During this 12-month period, A has the right to call its shares at their then-current fair value.
Entity A should assess the probability that it will call the shares within six months of the vesting of the stock
awards. Liability classification is required if it is probable that the shares will be called within six months from
the date the stock awards vest.
If A is an SEC registrant and the stock awards are not classified as a liability, temporary equity classification of
the stock awards will not be required under ASC 480-10-S99-3A because that guidance does not apply to stock
awards with redemption features that are solely within the control of the issuer.
5.3.2.2 Repurchase Features — Contingently Callable Stock Awards
Is the repurchase price at fair

Yes No
Is it
probable that
Is it probable that
call exercisable) less than six
call exercisable) while the
repurchase feature is
outstanding?
are issued or
issuable?
Yes No No Yes
Treat as a noncontingent callable Treat as a noncontingent callable

The stock award is classified as stock award at non–fair value (see
stock award at fair value (see
equity. Section 5.3.2.1).
Section 5.3.2.1).
4
See footnote 2.
230
An entity should analyze a contingent call option that becomes exercisable only upon the occurrence of
a specified future event (i.e., the triggering event) to determine whether it is probable that the triggering
event will occur on an individual-grantee basis. For repurchase features that are measured at fair value
as of the repurchase date, the probability assessment should cover the period during which the shares
are immature (i.e., within six months of vesting). For repurchase features that are not measured at fair
value as of the repurchase date, the probability assessment should generally cover the period during
which the repurchase feature is outstanding. In the latter situation, whether the shares are immature
or mature is generally not relevant to the probability assessment since the grantee would generally
not be subject to the risks and rewards of share ownership if the non–fair value repurchase feature
is exercised, regardless of whether the repurchase feature is exercised more than six months after
the shares vest. In addition, unlike the put option assessment, the probability assessment may be
performed regardless of whether the occurrence of the triggering event is solely in the control of the
party that can exercise the repurchase feature (i.e., the entity for call options). If it is not probable that
the triggering event will occur while the shares are immature (for fair value repurchase features) or at
any time before the repurchase feature expires (for non–fair value repurchase features), the repurchase
feature will not result in liability classification. If it is probable that the triggering event will occur while the
shares are immature (for fair value repurchase features) or at any time before the repurchase feature
expires (for non–fair value repurchase features), the entity should analyze the repurchase feature as if it
is noncontingent (i.e., as if the triggering event already occurred). See Section 5.3.2.1 for a discussion of
the accounting for noncontingent repurchase features associated with a call option.
Like noncontingent callable stock awards, contingently callable stock awards must be continually
assessed by entities to ensure that they are appropriately classified. Awards may be initially classified as
equity awards but, as a result of a change in the probability assessment, may be subsequently classified
as liability awards. Likewise, awards that are initially classified as liability awards may be subsequently
classified as equity awards if, for example, (1) there is a change in the probability assessment, (2) the
repurchase feature expires, or (3) for fair value repurchase features, the shares are held for at least six
months after the awards vest (i.e., the shares are no longer immature).
Example 5-9
service (cliff vesting). If employment is terminated for any reason after vesting, A has the right to call its shares
at their then-current fair value.
Entity A should assess the probability that employment will terminate within six months of the vesting of
the stock awards (this assessment is performed on an individual-employee basis). If it is not probable that
employment will terminate within six months of vesting, the stock awards are classified as equity. If it is
probable that employment will terminate within six months of vesting, A should treat the repurchase feature as
if it is noncontingent and determine whether it is probable that it will call the shares within six months from the
date the stock awards vest.
Example 5-10
service (cliff vesting). If employment is terminated for any reason after vesting, A has the right to call its shares
at a formula price that is not fair value. The call option expires if A effects an IPO or undergoes a change in
control.
231
Entity A should assess the probability that employment will terminate while the repurchase feature is
outstanding. While it is certain that employment will terminate at some point, in certain circumstances it may
be appropriate to perform the probability assessment (on an individual-employee basis) for the period before
an expected IPO or change in control (e.g., there is a single controlling shareholder that has an exit strategy
for the entity and a past practice of fulfilling similar exit strategies for its investments). If it is not probable that
employment will terminate during that period, the stock awards are classified as equity. If it is probable that
employment will terminate during that period, A should treat the repurchase feature as if it is noncontingent
and determine whether it is probable that it will call the shares during that period. If the formula price could
potentially be below fair value on the repurchase date, it is generally probable that the call feature will be
exercised.
5.3.3 Book-Value Plans for Employees

ASC 718-10
Example 8: Book Value Plans for Employees

55-131 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.
55-132 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.
55-133 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.
Certain employee share-based payment transactions that are based on a book or formula plan may
not be compensatory or classified as liabilities. If employees purchase shares at a formula price and
the shares have repurchase features that use that same formula price, there may be no compensation
cost if the same formula price is used for all transactions in the same class of shares (or in substantially
similar classes of shares). In such circumstances, the formula price essentially establishes the fair value
of the shares. The entity must still evaluate the repurchase feature under ASC 718-10-25-9 to determine
whether it would cause the shares to be classified as liabilities. If the repurchase price essentially is at
fair value, liability classification would not be required if the repurchase feature can only be exercised
after six months. See Sections 5.3.1 and 5.3.2 for a discussion of the treatment of repurchase features
with a fair value repurchase price.
232
5.3.4 Repurchase Features That Function as Vesting Conditions or Clawback

Features
Some awards have repurchase features exercisable by an entity (i.e., call options) with a repurchase
price that is (1) equal to the cost of the shares or (2) the lower of cost or fair value. The repurchase
features for such awards function as in-substance vesting conditions or clawback features, and do
not affect the awards’ classification (i.e., the analysis in Sections 5.3.1 and 5.3.2 related to repurchase
features is not required) because they do not represent, in substance, cash settlement features.
See Sections 3.4.3 and 3.9 for further discussion of features that function as vesting conditions and
clawback features.
5.4 Stock Options
ASC 718-10
25-11 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.
25-12 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.
The sections below discuss guidance on the classification of stock options and similar instruments. See
Section 5.3 for guidance on determining the classification of puttable and callable stock awards.
5.4.1 Classification of Underlying Shares

Stock options and similar instruments are classified as liabilities if the underlying shares are classified as
liabilities. For example, if the underlying shares of an option award have repurchase features, an entity
would first consider whether to classify the underlying shares as liabilities under ASC 718. See Section
5.3 for guidance on the classification of shares with repurchase features. While grantees generally begin
to bear the risks and rewards of share ownership when stock awards vest, they do not do so when stock
options vest. Rather, grantees begin to bear the risks and rewards of share ownership when the stock
options are exercised and the underlying shares are issued or issuable.
5.4.2 Cash Settlement Features

When stock option awards contain cash settlement features, an entity should perform the steps
indicated in the table and flowchart below. Note that these steps only apply to stock options and
similar instruments subject to ASC 718 that contain features that transfer cash or other assets upon
settlement. They therefore do not apply to the following awards:
• Stock options and similar instruments that will be settled upon the issuance of shares that
themselves must be classified as liabilities under ASC 718-10-25-11(a) and 25-12. See the
previous section.
233
• Share-based payment awards of puttable or callable shares subject to ASC 718. Such awards
must be classified in accordance with ASC 718-10-25-9 and 25-10. See Section 5.3 for guidance
on determining the classification of puttable and callable stock awards. ASC 718-10-25-9 and
25-10 also apply to stock options and similar instruments in which the underlying shares
are puttable or callable. The grantee does not begin to bear the risks and rewards normally
associated with share ownership of such instruments until they are exercised.
The table and decision tree below outline an entity’s step-by-step analysis in determining the
classification of stock options and similar instruments with cash settlement features.
Determining the Classification of Employee Stock Options and Similar Instruments With Cash
Settlement Features
Step Question Answer
1 Is cash settlement required, or can the grantee If yes, proceed to step 1a. If no, proceed to step 2.
elect either cash or share settlement of the stock
option or similar instrument (i.e., is the method of
settlement within the grantee’s control)?
a. Is the requirement to cash settle or the If yes, proceed to step 1b. If no, classify the stock
grantee’s election to cash settle contingent option or similar instrument as a share-based
on the occurrence of an event? liability.
b. If the requirement to cash settle or If yes, classify the stock option or similar
the grantee’s election to cash settle is instrument as a share-based liability. If no, proceed
contingent on the occurrence of an event, to step 1c.
is the contingent event within the grantee’s
control (e.g., voluntary termination of
employment)?
c. If the requirement to cash settle or If yes, classify the stock option or similar
the grantee’s election to cash settle is instrument as a share-based liability. If no, proceed
contingent on the occurrence of an event to step 2.
that is not within the grantee’s control (e.g.,
a change in control), is it probable that the
contingent event will occur?
2 Can the entity choose the method of settlement If yes, proceed to step 2a. If no, proceed to step 3.
(i.e., cash or share settlement) of the stock option
or similar instrument?
a. Is the entity’s election contingent on the If yes, proceed to step 2b. If no, proceed to step 2c.
occurrence of an event?
b. If the entity’s election is contingent on the If yes, proceed to step 2c. If no, proceed to step 3.
occurrence of an event, is the contingent
event solely within the grantee’s control or
is it probable that the event will occur?
c. Does the entity have the intent and ability to If yes, proceed to step 3. If no, classify the stock
settle the stock option or similar instrument option or similar instrument as a share-based
in the entity’s shares? liability.
3 Is temporary-equity classification of the stock If yes, classify the stock option or similar
option or similar instrument required under SAB instrument outside of permanent equity as
Topic 14.E? This step applies to SEC registrants, temporary (or mezzanine) equity. If no, classify the
and non-SEC registrants may elect not to apply it. stock option or similar instrument as permanent
equity.
234
Step 1
Is cash settlement
required, or can the
Step 2
grantee elect either cash or No
share settlement of the stock option (See step 2 decision tree on the
or similar instrument (i.e., is next page.)
the method of settlement
within the grantee’s
control)?
No
Yes
If the
If the requirement
Is the requirement to cash to cash settle or
requirement settle or the grantee’s the grantee’s election to
to cash settle or the Yes election to cash settle is No cash settle is contingent on
grantee’s election to cash contingent on the occurrence of the occurrence of an event that is
settle contingent on an event, is the contingent not within the grantee’s control
the occurrence of event within the grantee’s (e.g., a change in control),
an event? control (e.g., voluntary is it probable that the
termination)? contingent event
will occur?
No
Yes Yes
Classify the stock option or
similar instrument as a liability.
235
Classify the stock option or similar

instrument as a liability.
Step 2
Can the entity choose Is the entity’s election
Yes
the method of settlement contingent on the occurrence of No
(i.e., cash or share settlement) an event?
of the stock option or
similar instrument? No
Does the entity have

the intent and ability to
Yes settle the stock option or similar
instrument in the entity’s
shares?
No
Yes
If the entity’s
election is contingent
on the occurrence of an
event, is the contingent event
solely within the grantee’s
control or probable?
No
Yes
Step 3
Is temporary-equity
classification of the stock Classify the stock option or similar
option or similar instrument Yes instrument outside of permanent
required under SAB Topic 14.E? This equity as temporary (or mezzanine)
step applies to SEC registrants; equity.
non-SEC registrants may
elect not to apply it.
No
Classify the stock option or similar

instrument as permanent equity.
236
5.4.2.1 Noncontingent Cash Settlement Features (Including Tandem and

Combination Awards)
Many cash settlement features are not contingent on the occurrence of an event. If an entity is required
to settle stock options or similar instruments in cash or other assets (e.g., cash-settled SARs), the awards
should be classified as liabilities. Similarly, if the grantee can elect either cash or share settlement of
stock options or similar instruments (e.g., tandem awards), the awards should be classified as liabilities.
ASC 718 provides the examples below of tandem and combination awards for which the grantee can
elect the method of settlement.
ASC 718-10
Example 7: Tandem Awards

55-116 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).
55-116A Cases A and B of this Example (see paragraphs 718-10-55-117 through 55-130) 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.
55-116B 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.
Case A: Share Option or Cash Settled Stock Appreciation Rights

55-117 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.
55-118 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.
237
55-119 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.
Case B: Phantom Shares or Share Options

55-120 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.
55-121 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.
55-122 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.
55-123 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.
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
55-124 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.
55-125 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.
238
55-126 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.
55-127 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.
55-128 Compensation cost is measured based on the combined value of the two parts.
55-129 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.
Units (1,000 × $30) $ 30,000
Share options (2,000 × $10) 20,000
Value of award $ 50,000
55-130 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.
Many compensation arrangements include payments of both equity and cash. In some cases, the cash
component represents a liability-classified share-based payment award that is accounted for separately
from the equity-classified component (i.e., as a combination award). The examples below illustrate the
accounting for arrangements that are settled partially in cash and partially in equity.
Example 5-10A
Entity A grants to an executive restricted stock and stock options that vest at the end of four years (cliff vesting).
The award requires A to reimburse the executive in cash for federal income taxes at a rate of 37 percent
when the employee is taxed, which is when the employee vests in the restricted stock or exercises its stock
options. Provided that all the criteria for equity classification have been met, the restricted stock and stock
options will be separately accounted for as equity-classified share-based payment awards under ASC 718. In
addition, because A is required to pay the executive in cash amounts that are indexed to the fair value of the
underlying stock, those obligations are separately accounted for as liability-classified awards under ASC 718.
The tax obligation associated with the restricted stock is accounted for as cash-settled RSUs and measured on
the basis of 37 percent of the value of the underlying restricted stock. In addition, the tax obligation associated
with the stock options is accounted for as cash-settled SARs. Both liability-classified awards are required to be
remeasured in each reporting period and recognized as compensation cost.
239
Example 5-10B
Entity A establishes an entity-wide bonus program that provides each employee with an annual targeted
compensation rate. At the beginning of every year, each employee is notified of his or her targeted rate and
the composition in shares of common stock and cash, which both vest over a one-year period (cliff vesting).
Employee B’s targeted rate is $100,000 with a 50/50 equity-to-cash split, and each share is worth $50;
therefore, B will receive a cash bonus of $50,000 and a stock award worth $50,000 (1,000 shares, which is
$50,000 divided by the stock price of $50). If, upon vesting, the value of B’s total compensation is below the
targeted rate, B will receive an additional cash bonus for the difference. If the stock price increases from the
grant date, no additional cash bonus is paid. However, if the stock price decreases from the grant date, B will
receive a cash bonus equal to the decrease in value. For example, if B receives stock worth $60,000 on the
vesting date, B will not receive any additional cash bonus. By contrast, if the stock is worth $40,000 on the
vesting date, B will receive an additional cash bonus of $10,000. In effect, A has guaranteed that the employee
will be paid a minimum of $100,000 in cash and equity upon earning the bonus.
The $50,000 cash bonus is not subject to ASC 718 since it is not indexed to A’s equity value (i.e., it is recognized
as a fixed-price liability over the one-year vesting period). Provided that all the criteria for equity classification
have been met, the restricted stock award will be separately accounted for as an equity-classified award under
ASC 718 and recognized as compensation cost over the one-year requisite service period. The cash-settled
guarantee is indexed to A’s common stock and is therefore accounted for as a put option under ASC 718.
That cash-settled share-based liability should be remeasured in each reporting period and recognized as
compensation cost over the one-year requisite service period.
An entity that can elect a settlement method should consider the guidance in ASC 718-10-25-15,
which requires an entity to evaluate its intent and ability to settle in shares. In addition, an entity’s past
practices related to cash settlement could indicate that the awards should be classified as substantive
liabilities. Section 5.6 discusses considerations for an entity that can choose the method of settlement in
determining the classification of options and similar instruments.
5.4.2.2 Contingent Cash Settlement Features

An entity should analyze a contingent cash settlement feature that becomes exercisable only upon the
occurrence of a specified future event (i.e., the triggering event) to determine whether the triggering
event is within the control of the grantee. Triggering events within the grantee’s control should be
ignored in the entity’s analysis, and the entity should assess the options or similar instruments as if the
triggering event has already occurred. Options or similar instruments that require or permit the grantee
to cash settle the options or similar instruments must be classified as liabilities. Alternatively, options or
similar instruments that permit the entity to choose settlement in cash or shares are not classified as
liabilities unless they are substantive liabilities under ASC 718-10-25-15.
ASC 718-10-25-11 states that if a contingent cash settlement feature becomes exercisable upon a
triggering event that is not within the control of the grantee, and the grantee can choose the method
of settlement or the entity is required to settle in cash or other assets, the stock option or similar
instrument will not result in liability classification if it is not probable that the triggering event will occur.
The assessment of probability is generally performed on an individual-grantee basis. For example,
a stock option that can require cash settlement upon a change in control should not be classified
as a liability unless a change in control is considered probable. Generally, a change in control is not
considered probable until the event that triggers it has occurred (e.g., when a business combination has
been consummated).
240
If a contingent cash settlement feature becomes exercisable upon a triggering event that is not within
the control of the grantee, and the entity can determine the method of settlement, the stock option or
similar instrument will not result in liability classification if it is not probable that the event will occur. The
probability assessment is generally performed on an individual-grantee basis. If it becomes probable
that the triggering event will occur, the entity must consider the substantive terms of the option or
similar instrument under ASC 718-10-25-15, including the entity’s intent and ability to settle the option
or similar instrument in shares and the entity’s past practices of settling options or similar instruments.
Section 5.6 discusses considerations for an entity that can choose the method of settlement in
determining the classification of options and similar instruments.
Note that SEC registrants must consider the requirements of ASR 268 (FRR Section 211) and ASC
480-10-S99-3A, as discussed in SAB Topic 14.E. In accordance with that guidance, SEC registrants
must present outside of permanent equity (i.e., as temporary or mezzanine equity) options and similar
instruments (otherwise classified as equity) that are subject to cash settlement features that are not
solely within the control of the issuer. Temporary equity classification is required even if the options or
similar instruments otherwise qualify for equity classification under ASC 718 (e.g., an option that can be
cash settled upon a change in control). See Section 5.10 for a discussion and example of the application
of ASR 268 and ASC 480-10-S99-3A to stock options with a contingent cash settlement feature.
The redemption value at issuance is based on the cash settlement feature of the option or similar
instrument. For example, the redemption value of an option that can be cash settled at intrinsic value is
the intrinsic value of the option. Thus, if a stock option is granted at-the-money, its initial carrying value
would be zero. Subsequent remeasurement in temporary equity is not required under ASC 480-10-
S99-3A unless it is probable that the triggering event will occur, in which case the option or similar
instrument would be reclassified as a liability under ASC 718. As indicated in ASC 718-10-35-15, an entity
would account for a reclassified stock option or similar instrument in essentially the same way it would
account for a modification that changes the award’s classification from equity to liability. See Section
6.8.1 for a discussion and examples of the accounting for the modification of an award that changes the
award’s classification from equity to liability.
An entity does not need to consider ASC 480-10-S99-3A if it can choose the method of settlement (i.e.,
cash or share settlement) since that guidance applies only to awards with redemption features not
solely within the control of the issuer. An option or similar instrument with terms that allow the entity to
choose the method of settlement will never be classified as temporary equity.
5.4.2.3 Early Exercise of a Stock Option or Similar Instrument

An early exercise refers to a grantee’s ability to change his or her tax position by exercising an option or
similar instrument and receiving shares before the award is vested.
Because the awards are exercised before vesting, if the grantee ceases to provide goods or services
before the end of this period, the entity issuing the shares usually can repurchase the shares for either
of the following:
award.
241
The purpose of the repurchase feature is effectively to require the grantee to provide goods or
services to receive any economic benefit from the award. Because the repurchase feature functions
as a forfeiture provision, an entity would not consider the provisions of ASC 718-10-25-9 and 25-10 to
determine the classification of the award. In addition, because the early exercise is not considered to
be a substantive exercise for accounting purposes, the payment received by the entity for the exercise
price should generally be recognized as a deposit liability. See Section 3.4.3 for additional discussion on
an early exercise of a stock option or similar instrument.
5.4.3 Net Share Settlement Features

Some share-based payment arrangements contain features that allow grantees to net share settle
vested options or similar instruments. These features, which are sometimes referred to as stock option
pyramiding, phantom stock-for-stock exercises, or immaculate cashless exercises, allow the grantee to
exercise an option without having to pay the exercise price in cash. As a result of the settlement feature,
the grantee receives upon exercise a number of shares with a fair value equal to the intrinsic value of
the exercised options.
A net share settlement feature by itself does not result in liability classification of an option. An option
that can be net share settled is no different from a share-settled SAR and is not required to be
classified as a share-based liability. However, an option may include other features that result in liability
classification. See Section 5.4.2 for guidance on determining the classification of stock options with cash
settlement features.
5.4.4 Broker-Assisted Cashless Exercise

Broker-Assisted Cashless Exercise

The simultaneous exercise by a grantee of a share option and sale of the shares through a broker (commonly
referred to as a broker-assisted exercise).
Generally, under this method of exercise:

a. The grantee authorizes the exercise of an option and the immediate sale of the option shares in the
open market.
b. On the same day, the entity notifies the broker of the sale order.
c. The broker executes the sale and notifies the entity of the sales price.
d. The entity determines the minimum statutory tax-withholding requirements.
e. By the settlement day (generally three days later), the entity delivers the stock certificates to the broker.
f. On the settlement day, the broker makes payment to the entity for the exercise price and the minimum
statutory withholding taxes and remits the balance of the net sales proceeds to the grantee.
242
ASC 718-10
25-16 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).
25-17 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.
The exercise of stock options and similar instruments is often accomplished through a broker. A
feature that permits grantees to effect a broker-assisted cashless exercise would not be deemed a cash
settlement feature (that could cause liability classification) if the criteria in ASC 718-10-25-16 and 25-17
are met.
In addition, while ASC 718 does not define a “legal owner,” paragraph 245 of EITF Issue 00-23 states:
As the legal owner of the shares, the employee assumes market risk from the moment of exercise4 until the
broker effects the sale in the open market. While the period of time that the employee is exposed to such risk
may be inconsequential, it is no less of a period of time than might lapse if the employee paid cash for the full
exercise price and immediately sold the shares through an independent broker. If the employee were never the
legal owner of the option shares, the stock option would be in substance a stock appreciation right for which
[liability] accounting is required. If the related-party broker acquires the shares for its own account rather than
selling the shares in the open market, the grantor has, in effect, paid cash to an employee to settle an award,
which is a transaction for which compensation expense should be recognized. Conversely, the sale of the
option shares in the open market provides evidence that the marketplace, not the grantor (through its affiliate),
has acquired the option shares.
4
Under many cashless exercise programs, the broker will notify the employee if the aggregate sales price for
the option shares is less than the aggregate exercise price. In that situation, the employee may elect not to
exercise the options. As a result, the moment of exercise is deemed to be the moment that the shares
are sold.
While EITF Issue 00-23 was not codified in ASC 718, we believe that it is appropriate for entities to
consider in determining whether the grantee is the legal owner of the shares.
5.5 Indexation to Other Factors

ASC 718-10
25-13 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.
55-65 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.
243
ASC 718-10-25-13 indicates that when an award is indexed to a factor in addition to the entity’s share
price and that factor is not a market, performance, or service condition (i.e., it is an “other” condition), the
award must be classified as a liability. For example, an entity may link the exercise price of a stock option
to the change in the CPI or another similar index (such as the retail price index in the United Kingdom)
to eliminate the effect of inflation on the option’s value. Paragraph B127 of the Basis for Conclusions of
FASB Statement 123(R) explains the FASB’s reasoning for this treatment as follows:
The Board concluded that the terms of such an award do not establish an ownership relationship because
the extent to which (or whether) the employee benefits from the award depends on something other than
changes in the entity’s share price. That conclusion is consistent with the Board’s conclusion in Statement 150
that a share-settled obligation is a liability if it does not expose the holder of the instrument to certain risks and
rewards, including the risk of changes in the price of the issuing entity’s equity shares, that are similar to those
to which an owner is exposed.
A feature that adjusts the exercise price of an option for changes in the CPI does not meet the definition
of a market, performance, or service condition. Accordingly, such an award must be classified as a liability.
By contrast, an entity may (1) estimate the change in the CPI (or another similar index) over an option’s
vesting period or its expected life and (2) set a fixed exercise price that is adjusted for that estimate.
Because the exercise price is established as of the grant date and not linked to the actual change in
the CPI (or another similar index), the option is not considered to be indexed to a factor other than a
market, performance, or service condition. Accordingly, such an award, if it otherwise meets the criteria
for equity classification, is classified as equity.
In addition, questions have arisen related to the evaluation of whether an award is indexed to an “other”
condition or includes a feature that is a vesting or market condition. A vesting condition that is based
on an entity’s financial performance and is referenced solely to the grantor’s own operation in relation
to a peer group (e.g., attaining an EPS growth rate that outperforms the average EPS growth rate of
peer companies in the same industry) is a performance condition (see Sections 3.4.2 and 9.3.2.2 for
discussions of employee and nonemployee awards, respectively). Note that in these circumstances,
ASC 718 requires the performance measure ascribed to the award to be “defined by reference to the
same performance measure of another entity or group of entities” (emphasis added). That is, if the
performance measures are not equivalent, the condition is not a performance condition as defined
in ASC 718-10-20 and would result in the award’s classification as a liability. Examples of market
conditions that are defined by reference to an index include (1) a specified return on an entity’s stock
(often referred to as total shareholder return, or TSR) that exceeds the average return of a peer group
of entities or a specified index (such as the S&P 500) and (2) a percentage increase in an entity’s stock
price that is greater than the average percentage increase of the stock price of a peer group of entities
or a specified index (see Section 3.5). An entity must carefully evaluate the terms and conditions of each
award and use judgment in determining whether an award is indexed to a factor that is not a market,
performance, or service condition.
244
Example 5-11
Liability-Classified Award
Entity A grants employee stock options with a grant-date exercise price equal to the market price of A’s shares
that increases monthly for inflation (on the basis of changes in the CPI) through the date of exercise.
Because the options’ value is indexed to the CPI and the change in the CPI is a factor that is not considered a
market, performance, or service condition, the options must be classified as a liability. Entity A must remeasure
the options at their fair-value-based measure in each reporting period until settlement.
Alternatively, if the options’ terms only require monthly adjustments to the exercise price for changes in CPI
through the vesting date, the options would be classified as a liability only until the vesting date. That is, A only
must remeasure the options at their fair-value-based measure in each reporting period until the vesting date.
On the vesting date, the options’ value no longer is indexed to the CPI; therefore, as long as all the other criteria
for equity classification have been met, the award would be reclassified as equity.
Example 5-12
Equity-Classified Award
Entity A grants employee stock options with a grant-date exercise price equal to the grant-date market price
of A’s shares that increases annually by 3 percent (on the basis of A’s estimate of annual inflation) through
the date of exercise. Before considering the effects of the 3 percent annual increase to the exercise price, A
determines that the options should be classified as equity.
Because the options’ value is not indexed to a factor other than a market, performance, or service condition
(e.g., a change in the CPI), the options would be classified as equity. Accordingly, the fair-value-based measure
of the options is fixed on the grant date, and the increasing exercise price is incorporated into the fair-value-
based measure of the options.
ASC 718 provides an exception to liability classification when the exercise price of stock options is
denominated in a foreign currency and certain conditions are met. See Section 5.7.1 for a discussion of
this exception.
5.6 Substantive Terms
ASC 718-10
25-15 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 718-10-25-11 through 25-12).
245
An entity with the ability to choose the method of settlement (i.e., cash or share settlement) must
consider its intent and ability to settle the awards in cash or shares in determining whether to classify
the awards as equity or as a liability. The entity’s past practices related to the following may indicate that
some or all of the awards must be classified as a liability:
• Repurchasing awards for cash generally or whenever requested by a grantee.

• Net cash settling options.
The entity’s ability to deliver shares upon the vesting of stock awards or upon the exercise of stock
option awards must also be considered. The grantor must have enough unissued and authorized shares
to settle the awards. A requirement to provide registered shares does not, by itself, imply that the entity
does not have the ability to deliver shares. However, if the entity does not have enough unissued and
authorized shares to settle the awards in shares, liability classification of the awards may be required.
If the entity can choose the method of settlement (i.e., cash or share settlement), ASC 480-10-S99-3A
does not need to be considered since that guidance only applies to awards with redemption features
that are not solely within the control of the issuer. An award with terms that allow the entity to choose
the method of settlement will never be classified as temporary equity unless there are other redemption
features that are not solely within the entity’s control.
5.7 Exceptions to Liability Classification

5.7.1 Foreign Currency
ASC 718-10
25-14 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.
25-14A 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.
246
Stock options may have an exercise price that is denominated in a foreign currency (i.e., a currency that
is not the entity’s functional currency). While such foreign currency would not be a service, performance,
or market condition (i.e., it is an “other” condition), indexation to the currency, by itself, would not result
in liability classification of the stock options if:
• A grantee of an entity’s foreign operation is awarded stock options with a fixed exercise price
denominated in the foreign operation’s functional currency.
• A grantee of an entity’s foreign operation is awarded stock options with a fixed exercise price
denominated in the currency in which the employee’s pay is denominated.
• A grantee is awarded stock options with an exercise price denominated in the currency of a
market in which a substantial portion of the entity’s equity securities trades.
5.7.2 Statutory Tax Withholding Obligation

ASC 718-10
25-18 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.
25-19A 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.
In connection with an entity’s statutory tax withholding obligation, many share-based payment awards
permit the entity to repurchase, either directly or indirectly through a net settlement feature, a portion
of the shares that would otherwise be issued to employees (e.g., upon vesting of restricted stock or
upon stock option exercise). ASC 718-10-25-18 contains an exception to liability classification for this
share repurchase feature. Specifically, the net settlement of an award for statutory tax withholding
purposes would not, by itself, result in liability classification of the award provided that (1) the entity
has a statutory obligation to withhold taxes on the employees’ behalf and (2) the amount withheld for
taxes does not exceed the maximum statutory tax rates in the employees’ relevant tax jurisdictions. The
maximum statutory tax rate is based on the highest statutory tax rate in the employees’ jurisdictions
(determined on a jurisdiction-by-jurisdiction basis), even if that rate is more than the highest rate
applicable to a specific employee. If the amount withheld exceeds the maximum statutory tax rate, the
entire award is classified as a liability.
If an entity issues an award to a grantee that meets the definition of an employee under ASC 718-10
(i.e., is a common law employee) but the entity does not have a statutory obligation to withhold taxes on
behalf of the common law employee, the exception to liability accounting under ASC 718-10-25-18 does
not apply.
247
5.7.2.1 Hypothetical Withholdings
If employees work in multiple jurisdictions (e.g., mobile employees) or are on international assignment
(e.g., “ex-pat” employees), an entity may apply a “hypothetical” withholding rate to net settle their
share-based payment awards. The hypothetical amount for an ex-pat employee, for example, might
be based on the rate that would apply if the employee remained in the United States. To avoid liability
classification, the entity 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 employee’s relevant
tax jurisdictions. If a third-party service provider is involved in administering a company’s stock plan,
management should take steps to ensure that the service provider is (1) sufficiently conversant with the
statutory tax withholding obligations in the applicable jurisdiction(s) and (2) has access to the necessary
human resources and employment information needed to calculate the minimum withholding.
5.7.2.2 Cash Settlement of Fractional Shares

Because shares are typically withheld from employees in whole-number increments (the issuance of
fractional shares is typically prohibited), the value of a fractional share may be paid in cash directly
to the employee. For example, if 24.3 shares would be withheld to satisfy the entity’s statutory tax
withholding obligation, the entity typically withholds 25 shares and pays the difference (the value of a
fractional 0.7 share) in cash directly to the employee. ASC 718-10-25-18 does not appear to require
liability classification of an award as a result of a policy in which fractional shares must be cash settled.
Therefore, if the cash-settled portion is considered de minimis to the employee, it is not considered
a violation of ASC 718-10-25-18 to round up shares to meet the entity’s statutory tax withholding
obligation (up to the maximum statutory tax rate(s) in the employee’s applicable jurisdiction(s)).
However, an entity should evaluate the facts and circumstances of each arrangement to ensure that
(1) its substance does not create a liability and (2) the cash settlement of the fractional share is, in fact,
de minimis to the employee.
An arrangement may be a liability in substance, though, if (1) there are multiple exercises in small
increments (thereby increasing the number of fractional shares that are cash settled and thus the
amount of cash paid to a single employee) and (2) the entity’s per-share stock price is so high that the
cash paid for a fractional share could be significant.
5.7.2.3 Changes in the Amount Withheld

The classification of awards can be affected by the manner in which an entity remits tax savings to
employees as a result of overpayments made during the year to tax authorities to meet the entity’s
statutory tax withholding obligation. The example below illustrates how changes in the amount withheld
to meet an entity’s statutory tax withholding obligation can affect an award’s classification.
248
Example 5-13
Entity A has a statutory tax withholding obligation for an employee’s restricted stock award. The tax authorities
allow A to calculate the amount of taxes due on any date from the vesting date of an award to A’s year-end. For
administrative ease, on the vesting date, A (1) withheld, on the basis of the fair value of the shares on that date,
the amount of shares whose fair value is equal to the employee’s taxes by applying the maximum statutory tax
rate in the employee’s jurisdiction and (2) remitted that amount to the tax authorities. At year-end, A decides
to recalculate the tax withholding amount (also by applying the maximum statutory tax rate in the employee’s
jurisdiction), which results in a decreased withholding because of a decrease in the fair value of the entity’s
shares from the vesting date. The entity requests a refund from the tax authorities for the overpayment and
then remits the overpayment to the employee.
Entity A’s classification of the award depends on how it remits the tax savings (i.e., refund of overpayment) to the
employee. If the overpayment is remitted to the employee in cash, the transaction substantively represents the
repurchase of shares for an amount in excess of the maximum statutory tax rate in the employee’s jurisdiction.
As a result, in such circumstances, the entire award would have to be classified as a liability in accordance with
ASC 718-10-25-18. Alternatively, if the tax savings are remitted to the employee in shares, A should, to avoid any
adverse accounting consequences, determine the number of shares remitted to the employee by using the fair
value of the shares on the vesting date. In essence, A would divide the employee’s tax withholding determined at
year-end (on the basis of the maximum statutory tax rate in the employee’s jurisdiction and the fair value of the
shares on that date) by the fair value of the shares as of the vesting date to determine the amount that would
have been withheld as of the vesting date if A had known the employee’s year-end taxes (on the basis of the
maximum statutory tax rate) as of the vesting date. The excess number of shares between the new calculation
and initial calculation would then be remitted to the employee.
5.7.2.4 Nonemployee Director Tax Withholdings

While a nonemployee member of an entity’s board of directors may be treated similarly to an employee
under ASC 718 (see Section 2.3), the director is not considered an employee under the IRS’s statutory
withholding requirements. Because an entity does not have any statutory tax withholding requirements
in the United States related to nonemployee directors, the entity would not qualify for the exception to
liability classification in ASC 718-10-25-18. Thus, an entity’s practice of withholding shares to satisfy the
director’s tax obligation would result in liability classification of the entire award. The same would be true
for other nonemployee recipients of share-based payment awards for which statutory tax withholding
requirements would not apply (e.g., partners of partnerships or limited liability companies).
5.8 Awards That Become Subject to Other Guidance

ASC 718-10
Awards May Become Subject to Other Guidance

35-9 Paragraphs 718-10-35-10 through 35-14 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.
35-9A A convertible instrument award granted to a nonemployee in exchange for goods or services to be used
or consumed in a grantor’s own operations is subject to recognition and measurement guidance in this Topic
until the award is fully vested. Once vested, a convertible instrument award that is equity in form, or debt in
form, that can be converted into equity instruments of the grantor, shall follow recognition and measurement
through reference to other applicable generally accepted accounting principles (GAAP), including Subtopic
470-20 on debt with conversion and other options.
249
Pending Content (Transition Guidance: ASC 815-40-65-1)
35-9A Paragraph superseded by Accounting Standards Update No. 2020-06.
35-10 A freestanding financial instrument issued 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:
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.
35-10 A freestanding financial instrument or a convertible security issued 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:
35-10A 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.
35-11 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.
35-12 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.
250
35-14 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.
5.8.1 Awards Modified When the Grantee Is No Longer Providing Goods or

Services
A share-based payment award that is subject to ASC 718 generally does not become subject to other
applicable GAAP unless the award is modified when (1) the individual is no longer an employee, (2) the
nonemployee has vested in the award and is no longer providing goods or services, or (3) the grantee is
no longer a customer. Modifications made to an award when the holder is no longer an employee or the
nonemployee has vested in the award and is no longer providing goods or services should be accounted
for under ASC 718-10-35-11 through 35-14. After the modification, the award will become subject to
other applicable GAAP (e.g., ASC 815 and ASC 480). Note that once the award becomes subject to other
applicable GAAP, it is ineligible for any of ASC 718’s exceptions to liability classification.
There are two exceptions to this guidance, however, related to (1) certain equity restructurings (see the
next section) and (2) convertible instruments issued to nonemployees (see Section 9.5).
5.8.2 Equity Restructurings
ASC 718-10-35-10A clarifies the accounting treatment of changes to the terms of a share-based
payment award that are made solely to reflect an equity restructuring. While an equity restructuring is
considered a modification under ASC 718-20-35-6, an entity does not treat it as a modification when
applying ASC 718-10-35-10A (i.e., it is not subject to other applicable GAAP) if 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. . .) 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 . . . are treated in the same manner.
251
5.9 Change in Classification Due to Change in Probable Settlement Outcome

ASC 718-10
Change in Classification Due to Change in Probable Settlement Outcome

35-15 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.
An award’s classification can change even if the terms and conditions are not modified. For example, an
entity that can choose the settlement method of a stock option award could classify the award as equity
upon initially concluding that it has the intent and ability to settle the award with shares. However, the
entity could subsequently reclassify the award as a liability if it concludes that it no longer has the intent
or ability to settle the award with shares (i.e., it will cash settle the option award). In addition, an entity
that initially classifies a stock award as a liability (because a grantee has a noncontingent fair value put
option on the shares) could reclassify the award as equity once the grantee has borne the risks and
rewards of equity share ownership for six months after the stock award has vested, or for awards of
stock options, six months after the option has been exercised.
If an award’s classification changes as a result of changes in an entity’s facts and circumstances (e.g.,
from equity-classified to liability-classified or vice versa), the entity should account for the change in a
manner similar to a modification that changes classification, even if the award has not been modified.
The accounting will depend on the classification of the award before and after the change in facts and
circumstances. See Section 6.8 for further discussion of changes to the classification of an award as a
result of its modification.
252
5.10 SEC Guidance on Temporary Equity

SEC Staff Announcement: Classification and Measurement of Redeemable Securities

S99-3A
Background
1. This SEC staff announcement provides the SEC staff’s views regarding the application of Accounting
Series Release No. 268, Presentation in Financial Statements of “Redeemable Preferred Stocks.” FN1
Scope
2. ASR 268 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. As noted in ASR 268, the Commission reasoned that “[t]here
is a significant difference between a security with mandatory redemption requirements or whose
redemption is outside the control of the issuer and conventional equity capital. The Commission
believes that it is necessary to highlight the future cash obligations attached to this type of security so as
to distinguish it from permanent capital.”
3. Although ASR 268 specifically describes and discusses preferred securities, the SEC staff believes
that ASR 268 also provides analogous guidance for other redeemable equity instruments including,
for example, common stock, derivative instruments, noncontrolling interests,FN2 securities held by an
employee stock ownership plan,FN3 and share-based payment arrangements with employees.FN4 The SEC
staff’s views regarding the applicability of ASR 268 in certain situations is described below. . . .
d. Share-based payment awards. Equity-classified share-based payment arrangements with employees
are not subject to ASR 268 due solely to either of the following:
• Net cash settlement would be assumed pursuant to Paragraphs 815-40-25-11 through 25-16
solely because of an obligation to deliver registered shares.FN7
• A provision in an instrument for the direct or indirect repurchase of shares issued to an employee
exists solely to satisfy the employer’s minimum statutory tax withholding requirements (as
discussed in Paragraphs 718-10-25-18 through 25-19). . . .
ASR 268 (SEC Financial Reporting Codification, Section No. 211, Redeemable Preferred Stocks) is incorporated into SEC
FN1
Regulation S-X, Articles 5-02.27, 7-03.21, and 9-03.19. Hereafter, reference is made only to ASR 268.
The Master Glossary defines noncontrolling interest as “The portion of equity (net assets) in a subsidiary not attributable,
FN2
directly or indirectly, to a parent. A noncontrolling interest is sometimes called a minority interest.” ASR 268 applies to
redeemable noncontrolling interests (provided the redemption feature is not considered a freestanding option within the
scope of Subtopic 480-10). Where relevant, specific classification and measurement guidance pertaining to redeemable
noncontrolling interests has been included in this SEC staff announcement.
ASR 268 applies to equity securities held by an employee stock ownership plan (whether or not allocated) that, by
FN3
their terms, can be put to the registrant (sponsor) for cash or other assets. Where relevant, specific classification
and measurement guidance pertaining to employee stock ownership plans has been included in this SEC staff
announcement.
As indicated in Section 718-10-S99, ASR 268 applies to redeemable equity-classified instruments granted in conjunction
FN4
with share-based payment arrangements with employees. Where relevant, specific classification and measurement
guidance pertaining to share-based payment arrangements with employees has been included in this SEC staff
announcement.
See footnote 84 of Section 718-10-S99.
FN7
253
Classification
4. ASR 268 requires equity instruments with redemption features that are not solely within the control of
the issuer to be classified outside of permanent equity (often referred to as classification in “temporary
equity”). The SEC staff does not believe it is appropriate to classify a financial instrument (or host
contract) that meets the conditions for temporary equity classification under ASR 268 as a liability.FN10
5. Determining whether an equity instrument is redeemable at the option of the holder or upon the
occurrence of an event that is solely within the control of the issuer can be complex. The SEC staff
believes that all of the individual facts and circumstances surrounding events that could trigger
redemption should be evaluated separately and that the possibility that any triggering event that is not
solely within the control of the issuer could occur — without regard to probability — would require the
instrument to be classified in temporary equity. . . .
Measurement
12. Initial measurement. The SEC staff believes the initial carrying amount of a redeemable equity instrument
that is subject to ASR 268 should be its issuance date fair value, except as follows: FN12
a. For share-based payment arrangements with employees, the initial amount presented in temporary
equity should be based on the redemption provisions of the instrument and the proportion of
consideration received in the form of employee services at initial recognition. For example, upon
issuance of a fully vested option that allows the holder to put the option back to the issuer at its
intrinsic value upon a change in control, an amount representing the intrinsic value of the option at
the date of issuance should be presented in temporary equity. . . .
13. Subsequent measurement. The SEC staff’s views regarding the subsequent measurement of a redeemable
equity instrument that is subject to ASR 268 are included in paragraphs 14–16. Paragraphs 14 and 15
discuss the general views regarding subsequent measurement. Paragraph 16 discusses the application
of those general views in the context of certain types of redeemable equity instruments.
14. If an equity instrument subject to ASR 268 is currently redeemable (for example, at the option of the
holder), it should be adjusted to its maximum redemption amount at the balance sheet date. If the
maximum redemption amount is contingent on an index or other similar variable (for example, the fair
value of the equity instrument at the redemption date or a measure based on historical EBITDA), the
amount presented in temporary equity should be calculated based on the conditions that exist as of
the balance sheet date (for example, the current fair value of the equity instrument or the most recent
EBITDA measure). The redemption amount at each balance sheet date should also include amounts
representing dividends not currently declared or paid but which will be payable under the redemption
features or for which ultimate payment is not solely within the control of the registrant (for example,
dividends that will be payable out of future earnings).FN13
At the June 14, 2007 EITF meeting, the SEC Observer stated that a financial instrument (or host contract) that otherwise
FN10
meets the conditions for temporary equity classification may continue to be classified as a liability provided the financial
instrument (or host contract) was classified and accounted for as a liability in fiscal quarters beginning before September
15, 2007 and has not subsequently been modified or subject to a remeasurement (new basis) event.
SAB Topic 3C, Redeemable Preferred Stock, states that the initial carrying amount of redeemable preferred stock should
FN12
be its fair value at date of issue. The SEC staff believes this guidance should also be applied to other similar redeemable
equity instruments. Consistent with Paragraph 820-10-30-3, the transaction price will generally represent the initial fair
value of the equity instrument when the issuance occurs in an arm’s-length transaction with an unrelated party and there
are no other unstated rights or privileges.
See also Section 260-10-45.
FN13
254
15. If an equity instrument subject to ASR 268 is not currently redeemable (for example, a contingency has
not been met), subsequent adjustment of the amount presented in temporary equity is unnecessary if it
is not probable that the instrument will become redeemable. If it is probable that the equity instrument
will become redeemable (for example, when the redemption depends solely on the passage of time), the
SEC staff will not object to either of the following measurement methods provided the method is applied
consistently:
a. Accrete changes in the redemption value over the period from the date of issuance (or from the
date that it becomes probable that the instrument will become redeemable, if later) to the earliest
redemption date of the instrument using an appropriate methodology, usually the interest method.
Changes in the redemption value are considered to be changes in accounting estimates.
b. Recognize changes in the redemption value (for example, fair value) immediately as they occur and
adjust the carrying amount of the instrument to equal the redemption value at the end of each
reporting period. This method would view the end of the reporting period as if it were also the
redemption date for the instrument.
16. The following additional guidance is relevant to the application of the SEC staff’s views in paragraphs 14
and 15:
a. For share-based payment arrangements with employees, the amount presented in temporary equity
at each balance sheet date should be based on the redemption provisions of the instrument and
should take into account the proportion of consideration received in the form of employee services
(that is, the pattern of recognition of compensation cost pursuant to Topic 718).FN14 . . .
Reclassifications Into Permanent Equity
18. If classification of an equity instrument as temporary equity is no longer required (if, for example, a
redemption feature lapses, or there is a modification of the terms of the instrument), the existing carrying
amount of the equity instrument should be reclassified to permanent equity at the date of the event that
caused the reclassification. Prior financial statements are not adjusted. Additionally, the SEC staff believes
that it would be inappropriate to reverse any adjustments previously recorded to the carrying amount of
the equity instrument (pursuant to paragraphs 14–16) in conjunction with such reclassifications.
See also the Interpretative Response to Question 2 in Section E of Section 718-10-S99.

FN14
SAB Topic 14.E, FASB ASC Topic 718, Compensation — Stock Compensation, and Certain Redeemable
Financial Instruments [Reproduced in ASC 718-10-S99-1]
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.79 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.80 SEC Accounting Series Release No. 268, Presentation in Financial Statements
of “Redeemable Preferred Stocks,”81 (“ASR 268”) and related guidance82 address the classification and
measurement of certain redeemable equity instruments.
255
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 718,83 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 with employees 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.84
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.
79
The terminology outside the control of the issuer is used to refer to any of the three redemption conditions described in
Rule 5-02.28 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.
80
81
ASR 268, July 27, 1979, Rule 5-02.28 of Regulation S-X.
82
Related guidance includes FASB ASC paragraph 480-10-S99-3A (Distinguishing Liabilities from Equity Topic).
83
FASB ASC paragraph 718-10-35-13, states that an instrument ceases to be subject to this Topic when “the rights
conveyed by the instrument to the holder are no longer dependent on the holder being an employee of the entity (that
is, no longer dependent on providing service).”
84
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, 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).
256
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-capital85 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 issuers 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 intrinsic86 value of the option should be presented as temporary equity at that date.
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: See Topic 14.A for a discussion of the application of the principles in FASB ASC Topic
718 to nonemployee awards. The staff believes it would generally be appropriate to apply the methodology
described in the Interpretive Response to Question 2 above to nonemployee awards.
Depending on the fact pattern, this may be recorded as common stock and additional paid in capital.
85
The potential redemption amount of the share option in this illustration is its intrinsic value because the holder would
86
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.
To determine the classification of an award otherwise classified as equity under ASC 718, SEC registrants
must consider the requirements of ASR 268 (FRR Section 211) and ASC 480-10-S99-3A, as discussed in
SAB Topic 14.E, on redeemable securities. SEC registrants must present outside of permanent equity
(i.e., as temporary or mezzanine equity) share-based payment awards (otherwise classified as equity)
that are subject to redemption features not solely within the control of the issuer. Temporary-equity
classification may be required even if the share-based payment awards otherwise qualify for equity
classification under ASC 718 (e.g., a stock award that is contingently puttable by the grantee more than
six months after vesting at the then-current fair value). Exceptions include the following:
• The award does not require redemption for cash or other assets, and cash settlement would be
possible only upon the issuer’s inability to deliver registered shares (as described in ASC 815-40-
25-11 through 25-16).
• The award permits direct or indirect share repurchases only to satisfy the issuer’s statutory tax
withholding requirements (as described in ASC 718-10-25-18).
257
ASC 480-10-S99-3A and SAB Topic 14.E require that SEC registrants recognize and measure an award
with redemption features not solely within the control of the issuer in temporary equity as follows:
• At the award’s issuance, the entity should base the carrying value on its redemption value and
the proportion attributed to the employee requisite service rendered or nonemployee’s vesting
period recognized to date.
• Until the award’s settlement, the entity should remeasure the award at the end of the reporting
period on the basis of its redemption value and the proportion attributed to the employee
requisite services rendered or nonemployee’s vesting period recognized to date. Note that
remeasurement is not required for an award issued with contingent repurchase features if it
is not considered probable that the contingency would occur. The assessment of probability is
generally performed on an individual-grantee basis.
• The amount of compensation cost recognized should be based on the award’s grant-date fair-
value-based measure. Changes in the redemption value after the award is granted are recorded
in equity and not as compensation cost recognized in earnings.
The redemption value at issuance is based on the redemption feature of the award. For example, the
redemption value of an award that is redeemable at intrinsic value is the intrinsic value of the award.
Thus, if a stock option is granted at-the-money, its initial redemption value is zero. Alternatively, the
redemption value of an option that is redeemable at fair value is the fair value of the option. In a
situation in which a stock option is granted and the underlying share is redeemable at fair value, the
redemption value of the stock option is the intrinsic value and, after exercise, the redemption value of
the share is the fair value of the share. Subsequent remeasurement (if required under ASC 480-10-S99-
3A) will be based on the fair value of the issuer’s shares in each period, less the exercise price of the
award, if any. For guidance on reclassifications between permanent and temporary equity, see Section
9.7.4 of Deloitte’s Roadmap Distinguishing Liabilities From Equity.
The example below illustrates the application of ASR 268 and ASC 480-10-S99-3A to stock awards with
repurchase features. Example 5-15 illustrates the application of ASR 268 and ASC 480-10-S99-3A to
stock options with a contingent cash settlement feature.
Example 5-14
On January 1, 20X1, Entity A, an SEC registrant, grants 100,000 shares of restricted stock to an employee. The
stock awards vest at the end of the fourth year of service (cliff vesting). The stock awards give the employee the
right to require A to buy back A’s shares at their then-current fair value any time after six months from the date
the stock awards are fully vested. The fair value of the shares is as follows:
• $10 on January 1, 20X1.

• $12 on December 31, 20X1.
The repurchase feature will not result in liability classification of the stock awards since the employee will bear
the risks and rewards of share ownership for a period of more than six months after the stock awards have
vested. However, as an SEC registrant, A must apply ASR 268 and ASC 480-10-S99-3A. That guidance requires
an SEC registrant to present outside of permanent equity (i.e., as temporary or mezzanine equity) share-based
payment awards (otherwise classified as equity) that are subject to redemption features not solely within the
control of the issuer.
258
Entity A should record the following journal entries:

Temporary equity 250,000
To recognize compensation cost on the basis of the grant-date fair-
value-based measure of the stock awards (100,000 stock awards ×
$10 grant-date fair-value-based measure × 25 percent for one of
four years of service rendered).

To remeasure the stock awards at their redemption value as of
December 31, 20X1 [(100,000 stock awards × $12 fair value of
A’s shares × 25 percent for one of four years of service
rendered) – $250,000 carrying value of the stock awards].

value-based measure of the stock awards [(100,000 stock awards ×
$10 grant-date fair-value-based measure × 50 percent for two
of four years of service rendered) – $250,000 compensation cost
previously recognized].

December 31, 20X2 [(100,000 stock awards × $7 fair value of A’s
shares × 50 percent for two of four years of service rendered) –
$550,000 carrying value of the stock awards].

value-based measure of the stock awards [(100,000 stock awards
× $10 grant-date fair-value-based measure × 75 percent for three

shares × 75 percent for three of four years of service rendered) –
$600,000 carrying value of the stock awards].
259

value-based measure of the stock awards [(100,000 stock awards
× $10 grant-date fair-value-based measure × 100 percent for four

shares × 100 percent for four of four years of service rendered) –
$1,075,000 carrying value of the stock awards].
Example 5-15
On January 1, 20X1, Entity A, an SEC registrant, grants 100,000 stock options to an employee, each with a grant-
date fair-value-based measure of $8. The options are granted with a $10 exercise price when A’s share price
is $15 (i.e., the options have an intrinsic value of $5 per share on the grant date). The options vest at the end
of the second year of service (cliff vesting) and give the employee the right to require A to net cash settle the
options upon a change of control. On February 1, 20X3, when the fair-value-based measure of the options is
$15, a change of control becomes probable. Note that in accordance with ASC 805-20-55-50 and 55-51, which
discuss liabilities that are triggered upon the consummation of a business combination, a change in control is
generally not considered probable until it occurs.
From the date of issuance, January 1, 20X1, to January 31, 20X3, the cash settlement feature will not result
in liability classification of the options since the change in control is not considered probable. However, on
February 1, 20X3, when the change of control becomes probable (i.e., the date it occurs), the options must be
reclassified as a share-based liability. The reclassification is accounted for in a manner similar to a modification
that changes the awards’ classification from equity to liability. That is, on the date the change in control occurs,
A recognizes a share-based liability for the portion of the options that are related to prior service, multiplied by
the options’ fair-value-based measure on that date. If the amount recognized as a share-based liability is less
than or equal to the amount previously recognized in equity, the offsetting amount is recorded to APIC (i.e.,
final compensation cost cannot be less than the grant-date fair-value-based measure). If, on the other hand,
the amount recognized as a share-based liability is greater than the amount previously recognized in equity,
the excess is recognized as compensation cost either immediately (for vested options) or over the remaining
service (vesting) period (for unvested options). Because the options are now classified as a liability, they are
remeasured at a fair-value-based measure in each reporting period until settlement.
In addition, as an SEC registrant, A must apply ASR 268 and ASC 480-10-S99-3A. As a result, from the date
of issuance, January 1, 20X1, to January 31, 20X3, A must classify any grant-date intrinsic value outside of
permanent equity (i.e., as temporary or mezzanine equity). ASC 480-10-S99-3A does not require subsequent
remeasurement in temporary equity unless it is probable that the triggering event will occur. However, as noted
above, on February 1, 20X3, when the change in control becomes probable, the options must be reclassified as
a share-based liability.
260
Entity A should record the following journal entries:

APIC 400,000
value-based measure of the options (100,000 options × $8 grant-
date fair-value-based measure × 50 percent for one of two years
of service rendered).
APIC 250,000
To reclassify a portion of the grant-date intrinsic value of the
options to temporary equity in accordance with ASC 480-10-
S99-3A (100,000 options × $5 grant-date intrinsic value × 50
percent for one of two years of service rendered).
APIC 400,000
To recognize compensation cost on the basis of the grant-date
fair-value-based measure of the options [(100,000 options × $8
grant-date fair-value-based measure × 100 percent for two of two
years of service rendered) – $400,000 compensation cost
APIC 250,000

To reclassify a portion of the grant-date intrinsic value of the
options to temporary equity in accordance with ASC 480-10-
S99-3A [(100,000 options × $5 grant-date intrinsic value × 100
percent for two of two years of service rendered) – $250,000
amount previously reclassified].
Journal Entries: February 1, 20X3
APIC 500,000
To reverse the amount previously recognized in temporary equity
in accordance with ASC 480-10-S99-3A once the change in control
becomes probable.
261
APIC 800,000
Share-based liability 1,500,000

To recognize (1) a share-based liability on the basis of the fair-value-
based measure of the options on the date the change in control
becomes probable and (2) compensation cost for the excess of
the share-based liability over the amount previously recognized
in equity. Because the options are now classified as a liability, A
must remeasure the options at a fair-value-based measure in
each reporting period until settlement.
262
Chapter 6 — Modifications
6.1 Accounting for the Effects of Modifications

Modification
A change in the terms or conditions of a share-based payment award.
ASC 718-20
Modification of an Award
35-2A An entity shall account for the effects of a modification as described in paragraphs 718-20-35-3 through
35-9, unless all the following are met:
a. The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used)
of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an
alternative measurement method is used) of the original award immediately before the original award is
modified. If the modification does not affect any of the inputs to the valuation technique that the entity
uses to value the award, the entity is not required to estimate the value immediately before and after
the modification.
b. The vesting conditions of the modified award are the same as the vesting conditions of the original
award immediately before the original award is modified.
c. The classification of the modified award as an equity instrument or a liability instrument is the same as
the classification of the original award immediately before the original award is modified.
The disclosure requirements in paragraphs 718-10-50-1 through 50-2A and 718-10-50-4 apply regardless of
whether an entity is required to apply modification accounting.
35-3 Except as described in paragraph 718-20-35-2A, a modification of the terms or conditions of an equity
award shall be treated as an exchange of the original award for a new award. In substance, the entity
repurchases the original instrument by issuing a new instrument of equal or greater value, incurring additional
compensation cost for any incremental value. The effects of a modification shall be measured as follows:
a. Incremental compensation cost shall be measured as the excess, if any, of the fair value of the
modified award determined in accordance with the provisions of this Topic over the fair value of the
original award immediately before its terms are modified, measured based on the share price and
other pertinent factors at that date. As indicated in paragraph 718-10-30-20, references to fair value
throughout this Topic shall be read also to encompass calculated value. The effect of the modification
on the number of instruments expected to vest also shall be reflected in determining incremental
compensation cost. The estimate at the modification date of the portion of the award expected to vest
shall be subsequently adjusted, if necessary, in accordance with paragraph 718-10-35-1D or 718-10-35-3
and other guidance in Examples 14 through 15 (see paragraphs 718-20-55-107 through 55-121).
263
b. Total recognized compensation cost for an equity award shall at least equal the fair value of the award
at the grant date unless at the date of the modification the performance or service conditions of the
original award are not expected to be satisfied. Thus, the total compensation cost measured at the date
of a modification shall be the sum of the following:
1. The portion of the grant-date fair value of the original award for which the promised good is
expected to be delivered (or has already been delivered) or the service is expected to be rendered
(or has already been rendered) at that date
2. The incremental cost resulting from the modification.
Compensation cost shall be subsequently adjusted, if necessary, in accordance with paragraph 718-10-
35-1D or 718-10-35-3 and other guidance in Examples 14 through 15 (see paragraphs 718-20-55-107
through 55-121).
c. A change in compensation cost for an equity award measured at intrinsic value in accordance with
paragraph 718-20-35-1 shall be measured by comparing the intrinsic value of the modified award, if any,
with the intrinsic value of the original award, if any, immediately before the modification.
35-3A 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 assess at the date of the modification whether the performance
or service conditions of the original award are expected to be satisfied when measuring the effects of the
modification in accordance with paragraph 718-20-35-3. However, the entity shall apply its accounting policy to
account for forfeitures when they occur when subsequently accounting for the modified award.
35-4 Examples 12 through 16 (see paragraphs 718-20-55-93 through 55-144) provide additional guidance on,
and illustrate the accounting for, modifications of both vested and nonvested awards, including a modification
that changes the classification of the related financial instruments from equity to liability or vice versa, and
modifications of vesting conditions. Paragraphs 718-10-35-9 through 35-14 provide additional guidance on
accounting for modifications of certain freestanding financial instruments that initially were subject to this Topic
but subsequently became subject to other applicable generally accepted accounting principles (GAAP).
Cancellation and Replacement

35-8 Except as described in paragraph 718-20-35-2A, cancellation of an award accompanied by the concurrent
grant of (or offer to grant) a replacement award or other valuable consideration shall be accounted for as a
modification of the terms of the cancelled award. (The phrase offer to grant is intended to cover situations in
which the service inception date precedes the grant date.) Therefore, incremental compensation cost shall be
measured as the excess of the fair value of the replacement award or other valuable consideration over the fair
value of the cancelled award at the cancellation date in accordance with paragraph 718-20-35-3. Thus, the total
compensation cost measured at the date of a cancellation and replacement shall be the portion of the grant-
date fair value of the original award for which the promised good is expected to be delivered (or has already
been delivered) or the service is expected to be rendered (or has already been rendered) at that date plus the
incremental cost resulting from the cancellation and replacement.
The guidance in this chapter primarily applies to modifications of equity-classified share-based payment
awards. Since liability awards are remeasured at their fair value at the end of each reporting period, an
entity does not need to apply special guidance when accounting for modifications of such awards if their
classification does not change. See Section 6.8 for a discussion of modifications that result in a change
in classification, and see Section 7.4 for a discussion of modifications of liability-classified awards.
264
ASC 718-10-20 defines a modification as “[a] change in the terms or conditions of a share-based
payment award.” However, an entity is not required to apply modification accounting if certain factors
are the same immediately before and after the modification. As shown below, the three criteria in ASC
718-20-35-2A must be met for a change in the terms or conditions of a share-based payment award not
to be accounted for as a modification under ASC 718-20-35-3.
Fair value of the

modified award
equals the fair value
of the original award
immediately before
modification1
Modification
accounting (ASC
718-20-35-3) is not
required but disclosure
requirements in ASC
718-10-50-2A and ASC
718-10-50-4 apply
Classification of the Vesting conditions

of the modified
original award is the
award are the same
same as that of the as those of the
modified award original award
A modification under ASC 718 is viewed as an exchange of the original award for a new award, typically
one with equal or greater value because (1) share-based payment awards are meant to incentivize
(rather than disincentivize) employees and (2) the legal form of such an award may prevent the
grantor from modifying it without the consent of the grantee, and a grantee is not likely to agree to a
modification that results in an award of lesser value. However, if the award is for stock options, the fair-
value-based measure may be less than the fair-value-based measure of the original award because a
shorter vesting period may result in a shorter expected term.
Any incremental value of the new (or modified) award generally is recorded as additional compensation
cost on the modification date (for vested awards) or over the remaining vesting period (for unvested
awards). The incremental value (i.e., incremental compensation cost) is computed as the excess of the
fair-value-based measure of the modified award on the modification date over the fair-value-based
measure of the original award immediately before the modification.
Incremental
Compensation Cost
$5
Fair Value of Fair Value of

Fair Value Original Award Modified Award
$10 $15 $20
January 1, 20X1 June 30, 20X1

Original Award Grant Date Modification Date
1
Compare calculated value or intrinsic value, rather than fair value, if such an alternative measurement method is used. See Section 6.1.1 for
additional discussion of the determination of whether the fair value (or calculated or intrinsic value) of the modified award equals that of the
original award immediately before the change occurs in the terms and conditions of the agreement.
265
In addition to considering whether a modification results in incremental compensation cost that must
be recognized, an entity must determine whether it should recognize the award’s original grant-date
fair-value-based measure for equity-classified awards. Total recognized compensation cost attributable
to an equity award that has been modified is, at least, the grant-date fair-value-based measure of the
original award unless the original award is not expected to vest under its original terms (i.e., the service
condition, the performance condition, or neither is expected to be achieved). (See Sections 6.3.3 and
6.3.4 for illustrations of awards that have been modified and are not expected to vest under the original
vesting conditions.) Therefore, total recognized compensation cost attributable to an award that has
been modified is generally the sum of (1) the grant-date fair-value-based measure of the original award
for which vesting has occurred or is expected to occur and (2) the incremental compensation cost
conveyed to the holder of the award as a result of the modification, if any. However, if the original award
is not expected to vest under its original terms, any compensation cost recognized is based on the
modification-date fair-value-based measure of the modified award (i.e., the grant-date fair-value-based
measure of the original award is disregarded).
The examples below illustrate the application of modification accounting to equity-classified awards and
are based on Example 1 in ASC 718-20-55-4 through 55-9.
ASC 718-20
Example 1: Accounting for Share Options With Service Conditions

55-4 The following Cases illustrate the guidance in paragraphs 718-10-35-1D through 35-1E for nonemployee
awards, paragraphs 718-10-35-2 through 35-7 for employee awards, and paragraphs 718-740-25-2 through
25-3 for both nonemployee and employee awards, except for the vesting provisions:
a. Share options with cliff vesting and forfeitures estimated in initial accruals of compensation cost (Case A)
b. Share options with graded vesting and forfeitures estimated in initial accruals of compensation cost
(Case B)
c. Share options with cliff vesting and forfeitures recognized when they occur (Case C).
55-4A Cases A through C (see paragraphs 718-20-55-10 through 55-34G) describe employee awards. However,
the principles on accounting for employee awards, except for the compensation cost attribution, are the same
for nonemployee awards. Consequently, all of the following in Case A are equally applicable to nonemployee
awards with the same features as the awards in Cases A through C (that is, awards with a specified time period
for vesting):
a. The assumptions in paragraphs 718-20-55-6 through 55-9
b. Total compensation cost considerations (including estimates of forfeitures) in paragraphs 718-20-55-10
through 55-12
c. Changes in the estimation of forfeitures in paragraphs 718-20-55-14 through 55-15
d. Exercise or expiration considerations in paragraphs 718-20-55-18 through 55-21 and 718-20-55-23.
Therefore, the guidance in those paragraphs may serve as implementation guidance for nonemployee awards.
Similarly, an entity also may elect to account for nonemployee award forfeitures as they occur as illustrated in
Case C (see paragraph 718-20-55-34A).
55-4B Nonemployee awards may be similar to employee awards (that is, cliff vesting or graded vesting).
However, the compensation cost attribution for awards to nonemployees may be the same as or different
from employee awards. 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
266
55-4C Because of the differences in compensation cost attribution, the accounting policy election illustrated in
Case B (see paragraph 718-20-55-25) does not apply to nonemployee awards.
55-5 Cases A, B, and C share all of the assumptions in paragraphs 718-20-55-6 through 55-34G, with the
following exceptions:
a. In Case C, Entity T has an accounting policy to account for forfeitures when they occur in accordance
with paragraph 718-10-35-3.
b. In Cases A and B, Entity T has an accounting policy to estimate the number of forfeitures expected to
occur, also in accordance with paragraph 718-10-35-3.
c. In Case B, the share options have graded vesting.
d. In Cases A and C, the share options have cliff vesting.
55-6 Entity T, a public entity, grants at-the-money employee share options with a contractual term of 10 years.
All share options vest at the end of three years (cliff vesting), which is an explicit service (and requisite service)
period of three years. The share options do not qualify as incentive stock options for U.S. tax purposes. The
enacted tax rate is 35 percent. In each Case, Entity T concludes that it will have sufficient future taxable income
to realize the deferred tax benefits from its share-based payment transactions.
55-7 The following table shows assumptions and information about the share options granted on January 1,
20X5 applicable to all Cases, except for expected forfeitures per year, which does not apply in Case C.
Share options granted 900,000
Employees granted options 3,000
Expected forfeitures per year 3.0%
Share price at the grant date $ 30
Exercise price $ 30
Contractual term of options 10 years
Risk-free interest rate over contractual term 1.5 to 4.3%
Expected volatility over contractual term 40 to 60%
Expected dividend yield over contractual term 1.0%
Suboptimal exercise factor 2
55-8 A suboptimal exercise factor of two means that exercise is generally expected to occur when the share
price reaches two times the share option’s exercise price. Option-pricing theory generally holds that the
optimal (or profit-maximizing) time to exercise an option is at the end of the option’s term; therefore, if an
option is exercised before the end of its term, that exercise is referred to as suboptimal. Suboptimal exercise
also is referred to as early exercise. Suboptimal or early exercise affects the expected term of an option. Early
exercise can be incorporated into option-pricing models through various means. In this Case, Entity T has
sufficient information to reasonably estimate early exercise and has incorporated it as a function of Entity
T’s future stock price changes (or the option’s intrinsic value). In this Case, the factor of 2 indicates that early
exercise would be expected to occur, on average, if the stock price reaches $60 per share ($30 × 2). Rather
than use its weighted average suboptimal exercise factor, Entity T also may use multiple factors based on a
distribution of early exercise data in relation to its stock price.
267
55-9 This Case assumes that each employee receives an equal grant of 300 options. Using as inputs the last 7
items from the table in paragraph 718-20-55-7, Entity T’s lattice-based valuation model produces a fair value
of $14.69 per option. A lattice model uses a suboptimal exercise factor to calculate the expected term (that is,
the expected term is an output) rather than the expected term being a separate input. If an entity uses a Black-
Scholes-Merton option-pricing formula, the expected term would be used as an input instead of a suboptimal
exercise factor.
Example 12: Modifications and Settlements

55-93 The following Cases illustrate the accounting for modifications of the terms of an award (see paragraphs
718-20-35-3 through 35-4) and are based on Example 1, Case A (see paragraph 718-20-55-10), in which Entity T
granted its employees 900,000 share options with an exercise price of $30 on January 1, 20X5:
a. Modification of vested share options (Case A)
b. Share settlement of vested share options (Case B)
c. Modification of nonvested share options (Case C)
d. Cash settlement of nonvested share options (Case D).
55-93A Cases A through D (see paragraphs 718-20-55-94 through 55-102) describe employee awards.
Specifically, each case is an extension of Case A in Example 1. However, the principles on how to account for
the various aspects of employee awards, except for the compensation cost attribution and certain inputs
to valuation, are the same for nonemployee awards. Consequently, the methodology for determining the
additional compensation cost that an entity should recognize upon modification or settlement in paragraphs
718-20-55-94 through 55-102 is equally applicable to nonemployee awards with the same features as the
awards in Cases A through D (that is, awards with a specified period of time for vesting). Therefore, the
guidance in those paragraphs may serve as implementation guidance for similar nonemployee awards.
55-93B All aspects of Case A (see paragraph 718-20-55-94) and Case B (see paragraph 718-20-55-97) that
illustrate a modification and share settlement of vested share options, respectively, including the immediate
recognition of any additional compensation cost, should be the same for both employee awards and
nonemployee awards.
55-93C The compensation cost attribution for awards to nonemployees may be the same or different for
employee awards in Case C (see paragraph 718-20-55-98), which illustrates the modification of a nonvested
share option. 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.
55-93D All aspects of Case D (see paragraph 718-20-55-102), which illustrates a cash settlement of a nonvested
share option, including the immediate recognition of any additional compensation cost, should be the same for
both employee awards and nonemployee awards. That is because the cash settlement of a nonvested share
option effectively vests the share option.
Case A: Modification of Vested Share Options

55-94 On January 1, 20X9, after the share options have vested, the market price of Entity T stock has declined
to $20 per share, and Entity T decides to reduce the exercise price of the outstanding share options to $20.
In effect, Entity T issues new share options with an exercise price of $20 and a contractual term equal to the
remaining contractual term of the original January 1, 20X5, share options, which is 6 years, in exchange for the
original vested share options. Entity T incurs additional compensation cost for the excess of the fair value of
the modified share options issued over the fair value of the original share options at the date of the exchange,
measured as shown in the following paragraph. A nonpublic entity using the calculated value would compare
the calculated value of the original award immediately before the modification with the calculated value of
the modified award unless an entity has ceased to use the calculated value, in which case it would follow the
guidance in paragraph 718-20-35-3(a) through (b) (calculating the effect of the modification based on the fair
value). The modified share options are immediately vested, and the additional compensation cost is recognized
in the period the modification occurs.
268
55-95 The January 1, 20X9, fair value of the modified award is $7.14. To determine the amount of additional
compensation cost arising from the modification, the fair value of the original vested share options assumed
to be repurchased is computed immediately before the modification. The resulting fair value at January 1,
20X9, of the original share options is $3.67 per share option, based on their remaining contractual term of 6
years, suboptimal exercise factor of 2, $20 current share price, $30 exercise price, risk-free interest rates of
1.5 percent to 3.4 percent, expected volatility of 35 percent to 50 percent and a 1.0 percent expected dividend
yield. The additional compensation cost stemming from the modification is $3.47 per share option, determined
as follows.
Fair value of modified share option at January 1, 20X9 $ 7.14
Less: Fair value of original share option at January 1, 20X9 3.67
Additional compensation cost to be recognized $ 3.47
55-96 Compensation cost already recognized during the vesting period of the original award is $10,981,157
for 747,526 vested share options (see paragraphs 718-20-55-14 through 55-17). For simplicity, it is assumed
that no share options were exercised before the modification. Previously recognized compensation cost is not
adjusted. Additional compensation cost of $2,593,915 (747,526 vested share options × $3.47) is recognized on
January 1, 20X9, because the modified share options are fully vested; any income tax effects from the additional
compensation cost are recognized accordingly.
Case B: Share Settlement of Vested Share Options

55-97 Rather than modify the option terms, Entity T offers to settle the original January 1, 20X5, share options
for fully vested equity shares at January 1, 20X9. The fair value of each share option is estimated the same way
as shown in Case A, resulting in a fair value of $3.67 per share option. Entity T recognizes the settlement as
the repurchase of an outstanding equity instrument, and no additional compensation cost is recognized at the
date of settlement unless the payment in fully vested equity shares exceeds $3.67 per share option. Previously
recognized compensation cost for the fair value of the original share options is not adjusted.
Case C: Modification of Nonvested Share Options

55-98 On January 1, 20X6, 1 year into the 3-year vesting period, the market price of Entity T stock has declined
to $20 per share, and Entity T decides to reduce the exercise price of the share options to $20. The three-
year cliff-vesting requirement is not changed. In effect, in exchange for the original nonvested share options,
Entity T grants new share options with an exercise price of $20 and a contractual term equal to the 9-year
remaining contractual term of the original share options granted on January 1, 20X5. Entity T incurs additional
compensation cost for the excess of the fair value of the modified share options issued over the fair value of
the original share options at the date of the exchange determined in the manner described in paragraphs
718-20-55-95 through 55-96. Entity T adds that additional compensation cost to the remaining unrecognized
compensation cost for the original share options at the date of modification and recognizes the total amount
ratably over the remaining two years of the three-year vesting period. Because the original vesting provision is
not changed, the modification has an explicit service period of two years, which represents the requisite service
period as well. Thus, incremental compensation cost resulting from the modification would be recognized
ratably over the remaining two years rather than in some other pattern.
269
55-99 The January 1, 20X6, fair value of the modified award is $8.59 per share option, based on its contractual
term of 9 years, suboptimal exercise factor of 2, $20 current share price, $20 exercise price, risk-free interest
rates of 1.5 percent to 4.0 percent, expected volatilities of 35 percent to 55 percent, and a 1.0 percent
expected dividend yield. The fair value of the original award immediately before the modification is $5.36 per
share option, based on its remaining contractual term of 9 years, suboptimal exercise factor of 2, $20 current
share price, $30 exercise price, risk-free interest rates of 1.5 percent to 4.0 percent, expected volatilities of
35 percent to 55 percent, and a 1.0 percent expected dividend yield. Thus, the additional compensation cost
stemming from the modification is $3.23 per share option, determined as follows.
Fair value of modified share option at January 1, 20X6 $ 8.59
Less: Fair value of original share option at January 1, 20X6 5.36
Incremental value of modified share option at January 1, 20X6 $ 3.23
55-100 On January 1, 20X6, the remaining balance of unrecognized compensation cost for the original share
options is $9.79 per share option. Using a value of $14.69 for the original option as noted in paragraph 718-20-
55-9 results in recognition of $4.90 ($14.69 ÷ 3) per year. The unrecognized balance at January 1, 20X6, is $9.79
($14.69 – $4.90) per option. The total compensation cost for each modified share option that is expected to
vest is $13.02, determined as follows.
Incremental value of modified share option $ 3.23
Unrecognized compensation cost for original share option 9.79
Total compensation cost to be recognized $ 13.02
55-101 That amount is recognized during 20X6 and 20X7, the two remaining years of the requisite service
period.
Example 16: Modifications Regarding an Award’s Classification

Case B: Equity to Equity Modification (Share Options to Shares)
55-134 Equity to equity modifications also are addressed in Examples 12 (see paragraph 718-20-55-93) and
14 (see paragraph 718-20-55-107). This Case is based on Example 1, Case A (see paragraph 718-20-55-10),
in which Entity T granted its employees 900,000 options with an exercise price of $30 on January 1, 20X5. At
January 1, 20X9, after 747,526 share options have vested, the market price of Entity T stock has declined to $8
per share, and Entity T offers to exchange 4 options with an assumed per-share-option fair value of $2 at the
date of exchange for 1 share of nonvested stock, with a market price of $8 per share. The nonvested stock will
cliff vest after two years of service. All option holders elect to participate, and at the date of exchange, Entity T
grants 186,881 (747,526 ÷ 4) nonvested shares of stock. Entity T considers the guidance in paragraph 718-20-
35-2A. Because the change in the terms or conditions of the award changes the vesting conditions of the
award, Entity T applies modification accounting. However, because the fair value of the nonvested stock is equal
to the fair value of the options, there is no incremental compensation cost. Entity T will not make any additional
accounting entries for the shares regardless of whether they vest, other than possibly reclassifying amounts
in equity; however, Entity T will need to account for the ultimate income tax effects related to the share-based
compensation arrangement.
270
Example 6-1
value-based measure of $9. The options vest at the end of the fourth year of service (cliff vesting). On January
1, 20X4, A modifies the options, which does not affect their remaining requisite service period. The fair-value-
based measure of the original options immediately before modification is $4, and the fair-value-based measure
of the modified options is $6.
Over the first three years of service, A records $6,750 (1,000 options × $9 grant-date fair-value-based
measure × 75% for three of four years of services rendered) of cumulative compensation cost. On the
modification date, A computes the incremental compensation cost as $2,000, or ($6 fair-value-based measure
of modified options – $4 fair-value-based measure of original options immediately before the modification) ×
1,000 options. The $2,000 incremental compensation cost is recorded over the remaining year of service. In
addition, A records the remaining $2,250 of compensation cost over the remaining year of service attributable
to the original options. Therefore, total compensation cost associated with these options is $11,000 ($9,000
grant-date fair-value-based measure + $2,000 incremental fair-value-based measure) recorded over four years
of required service for both the original and modified options.
Example 6-2
Assume all the same facts as in the example above, except that the options contain a graded vesting schedule
(i.e., 25 percent of the options vest at the end of each year of service). In accordance with the accounting policy
it has elected under ASC 718-10-35-8, A records compensation cost on a straight-line basis over the total
requisite service period for the entire award.
For the first three years of service, Entity A records $6,750 (1,000 options × $9 grant-date fair-value-based
measure × 75% for three of four years of services rendered) of cumulative compensation cost. On the date
of modification, A computes the incremental compensation cost as $2,000, or ($6 fair-value-based measure
of modified options – $4 fair-value-based measure of original options immediately before the modification) ×
1,000 options. Entity A records $1,500 of incremental compensation cost immediately because 75 percent of
the options have vested.
The remaining $500 of incremental compensation cost is recorded over the remaining year of service. In
addition, A records the remaining $2,250 of compensation cost over the remaining year of service attributable
to the original options. Therefore, total compensation cost associated with these options is $11,000 ($9,000
grant-date fair-value-based measure + $2,000 incremental fair-value-based measure).
Example 6-3
Entity B grants to its employees RSUs that are classified as equity and have a fair-value-based measure of $1
million on the grant date. Before the awards vest, B subsequently modifies them to add a contingent fair-value
repurchase feature on the underlying shares. Assume that the addition of the repurchase feature does not
change the fair-value-based measure of the awards or their classification and that the fair-value-based measure
on the modification date is $1.5 million (both immediately before and after the modification). In addition, there are
no other changes to the awards (including their vesting conditions). In accordance with ASC 718-20-35-2A,
B would not apply modification accounting because the fair-value-based measure, vesting conditions, and
classification of the awards are the same immediately before and after the modification. Accordingly, irrespective
of whether the awards are expected to vest on the modification date, any compensation cost recognized will
continue to be based on the grant-date fair-value-based measure of $1 million.
271
Changing Lanes
In May 2021, the FASB issued ASU 2021-04, which clarifies the accounting for modifications of
freestanding equity-classified written call options that are within the scope of ASC 815-40 and
remain equity classified after the modification. The ASU specifies that when freestanding equity-
classified written call options that are within the scope of ASC 815-40 are modified or exchanged
to compensate grantees in a share-based payment arrangement, an entity should recognize the
effects of such modification by applying the guidance in ASC 718; however, classification of the
options would still be subject to the requirements of ASC 815-40.
6.1.1 The Fair Value Assessment

Modification accounting is not required if certain conditions are met, one of which is that the fair-value-
based measure (or calculated value or intrinsic value if such an alternative measurement method is
used) must be the same immediately before and after the modification.
6.1.1.1 Determining Whether a Fair Value Calculation Is Required

An entity will not always need to estimate the fair-value-based measure of a modified award. An entity
might instead be able to determine whether the modification affects any of the inputs used in the
valuation technique performed for the award. For example, if an entity changes the net-settlement
terms of its share-based payment arrangements related to statutory tax withholding requirements, that
change is not likely to affect any inputs used to value the awards. If none of the inputs are affected, the
entity would not be required to estimate the fair-value-based measure immediately before and after the
modification (i.e., the entity could conclude that the fair-value-based measure is the same).
6.1.1.2 Considering Whether Compensation Cost Recognized Has Changed

The evaluation of whether the fair-value-based measure has changed should not be based on whether
the compensation cost recognized has changed. If an entity makes a modification that changes the fair-
value-based measure of an award, modification accounting would be applied. An entity’s assessment
of whether to apply modification accounting does not take into account a change in recognized
compensation cost. For example, if a modification changes the fair-value-based measure of an award
but it is not probable that the award will vest both immediately before and after the modification (a
“Type IV improbable-to-improbable” modification), there may be no change in compensation cost
recognized on the modification date because there is no compensation cost before and after the
modification (compensation cost is recognized only if it is probable that the award will vest). However,
modification accounting would be required (and a new measurement determined as of the modification
date) because the fair-value-based measure has changed; the new measurement should be used if it
becomes probable that the modified award will subsequently vest.
6.1.1.3 Determining the Unit of Account

In paragraphs BC19 and BC20 of ASU 2017-09, the FASB discusses the unit of account an entity would
apply in determining whether an award’s fair-value-based measure is the same immediately before
and after a modification. The discussion addresses questions from stakeholders about whether an
entity should compare the value of an award immediately before and after a modification on the
basis of (1) “the total instruments in an award to [a grantee] that are modified” or (2) “each individual
instrument awarded to [a grantee] that is modified.” The Board indicates that the unit of account should
be consistent with that applied under other guidance in ASC 718 and with the definition of an award
in the ASC master glossary. That is, an entity should use as the unit of account the total of all modified
instruments in the award rather than each individual modified instrument awarded to the grantee.
272
Example 6-4
Entity C grants 10,000 stock options that become significantly out-of-the-money after the grant date. To retain
the award’s original fair value, C modifies it by lowering the options’ exercise price and reducing their quantity
to 5,000. If C were to compare the fair-value-based measure of a single stock option in the original award
immediately before the modification with the fair-value-based measure of a single stock option in the modified
award immediately after the modification, the measure immediately before would be less than the measure
immediately after the modification. If a single stock option were the unit of account, C would be required to
apply modification accounting. However, C must base its assessment on the ASC master glossary’s definition of
an award. Although this award contains multiple instruments, the unit of account on which C performs the fair
value assessment is the total of all modified instruments awarded to the employee. Accordingly, C compares
the fair-value-based measure of the original 10,000 stock options with the fair-value-based measure of the
modified 5,000 stock options. In accordance with ASC 718-20-35-2A, C would not apply modification accounting
if the fair-value-based measure, vesting conditions, and classification of the awards are the same immediately
before and after the modification.
Example 6-5
Entity D grants 1,000 equity-classified stock options to an employee. All 1,000 options are granted at the same
time and contain the same terms and conditions. In accordance with the definition of “award” in the ASC master
glossary, the employee’s award consists of 1,000 options. After the grant date, the options become significantly
out-of-the-money, so D decides to reprice 500 of them by reducing their exercise price. However, D retains
the original exercise price for the other 500 options. Accordingly, the 500 modified options are now the award
as well as the unit of account in D’s assessment of whether it must apply modification accounting. Because
the fair-value-based measure of the 500 modified options has increased, D applies modification accounting.
However, because the other 500 stock options were not modified, that award is not subject to modification
accounting and continues to be recognized on the basis of its grant-date fair-value-based measure. While all
1,000 stock options were the award and the unit of account when granted, only the 500 modified stock options
are the award and the unit of account for modification accounting purposes because they were the only
instruments modified. In accordance with the definition of “award” in the ASC master glossary, “[r]eferences to
an award also apply to a portion of an award.”
6.1.1.4 Determining Whether the Fair Value Is the Same Before and After
Modification
In determining whether modification accounting is appropriate, some practitioners have expressed
uncertainty about whether the fair-value-based measure of an award must be exactly the same
immediately before and after the modification (i.e., a binary assessment) or whether they can apply
judgment on the basis of the significance of the change in the fair-value-based measure. The FASB
explained in ASU 2017-09 that it decided not to establish specific requirements regarding the use of
judgment in this assessment, observing that entities must use judgment to apply other aspects of ASC
718 and do so without relying on specific guidance. Accordingly, an entity may need to use judgment
in certain circumstances to determine whether the fair-value-based measure of an award is the same
immediately before and after a modification. For example, as a result of using judgment, an entity may
reasonably conclude that the fair-value-based measure is the same when a difference is de minimis and
the facts and circumstances indicate that the intent of the modification was to retain the award’s original
fair value.
273
Example 6-6
Entity E grants to an employee 1,000 equity-classified stock options that become significantly out-of-the-money
after the grant date. To retain the award’s original fair value, E decides to replace the 1,000 stock options
with 423 RSUs. The fair-value-based measure of the 1,000 stock options immediately before the modification
is $100,000, and the fair-value-based measure of the 423 RSUs is $100,010. The difference is de minimis
and solely attributable to E’s having rounded up the 423 RSUs, which it does because it is precluded from
issuing fractional shares. Accordingly, E concludes that the fair-value-based measure of the award is the same
immediately before and after the modification.
6.1.2 Examples of Changes for Which Modification Accounting Would or

Would Not Be Required
The Background Information and Basis for Conclusions of ASU 2017-09 provides examples (that
“are educational in nature, are not all-inclusive, and should not be used to override the guidance in
paragraph 718-20-35-2A”) of changes to awards for which modification accounting generally would or
would not be required. The table below summarizes those examples.
Examples of Changes for Which Modification Examples of Changes for Which Modification
Accounting Would Not Be Required Accounting Would Be Required
• Administrative changes, such as a change to the • Repricings of stock options that result in a
company name, company address, or plan name change in value
• Changes in net-settlement provisions related to tax • Changes in a service condition
withholdings that do not affect the classification of the
award
• Changes in a performance condition or a
market condition
• Changes in an award that result in a
reclassification of the award (equity to liability
or vice versa)
• Addition of an involuntary termination provision
in anticipation of a sale of a business unit that
accelerates vesting of an award
Share-based payment plans commonly contain clawback provisions that allow an entity to recoup
awards upon certain contingent events (e.g., termination for cause, violation of a noncompete provision,
material financial statement restatement), as discussed in Section 3.9. Under ASC 718-10-30-24, such
clawback provisions generally are not reflected in estimates of the fair-value-based measure of awards.
Accordingly, the addition of a clawback provision to an award would typically not result in the application
of modification accounting because such clawbacks generally do not change the award’s fair-value-
based measure, vesting conditions, or classification.
Example 6-7
Entity F grants 100,000 equity-classified stock options to its CEO. A year after the grant date, F modifies
the award to add a well-defined, objective, and nondiscretionary clawback provision related to a material
restatement of F’s financial statements. Entity F concludes that the modification does not change the award’s
fair-value-based measure, vesting conditions, or classification. In assessing whether the award’s fair-value-
based measure changes as a result of the modification, F determines that the addition of the clawback
provision does not affect any of the inputs used in the valuation technique since clawback provisions generally
are not reflected in estimates of the fair-value-based measure of awards. As a result, F concludes that it is not
required to apply modification accounting.
274
6.1.3 Tax Effects of Award Modifications

Modification of share-based payment agreements may have unintended tax consequences. For
example, a modification may affect the U.S. federal tax treatment of a nonstatutory option (i.e., an
NQSO) under IRC Section 409A, which could have significant tax consequences for the grantee of the
share-based payment award (see Section 4.12.2 for additional information on nonstatutory options and
IRC Section 409A) or result in a disqualifying event of an ISO (see Section 6.5.1.2).
In addition, modification of a share-based payment plan may change the deductibility of awards issued
to a “covered employee” under IRC Section 162(m) and how the limitations are applied for income tax
purposes. IRC Section 162(m) applies differently to (1) compensation arrangements entered into before
November 2, 2017 (that have not been materially modified on or after that date), and (2) compensation
arrangements entered into on or after November 2, 2017. Compensation arrangements that were in
place before this date are effectively “grandfathered” (i.e., legacy requirements apply). However, if a
modification occurs on or after this date, the award may no longer qualify for this exception. See Section
10.2.3 of Deloitte’s Roadmap Income Taxes for additional information.
Given the potential for unintended tax consequences associated with modifications to share-based
compensation plans, entities are urged to consult with their tax advisers.
6.2 Modification Date
To determine the accounting period in which to record any incremental compensation cost resulting
from an award’s modification as well as to measure the modification’s effect, an entity must establish a
modification date. For example, if the award is fully vested, the entity recognizes any incremental cost
entirely on the modification date. When establishing the modification date, the entity considers the same
conditions it does when establishing the grant date for the original share-based payment award.
As discussed in Section 3.2, a grant date is generally considered to be the date on which all of the
following conditions have been met:
• The entity and grantee have reached a mutual understanding of the key terms and conditions of
the share-based payment award (see Sections 3.2.2, 3.2.3, and 3.2.5).
• The grantee begins to benefit from, or be adversely affected by, subsequent changes in the price
of the entity’s equity shares for equity instruments (see Section 3.2.4).
• All necessary approvals have been obtained. 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). For example, if shareholder approval
is required but management and the members of the board of directors control enough votes
to approve the arrangement, shareholder approval is essentially a formality or perfunctory.
Similarly, individual awards that are subject to approval by the board of directors, management,
or both are not deemed to be granted until all such approvals are obtained (see Section 3.2.1).
• For awards to employees, the recipient meets the definition of an employee (see Section 2.2 for
guidance on the definition of an employee).
275
6.3 Impact of Vesting Conditions

ASC 718-20
Example 14: Modifications of Awards With Performance and Service Vesting Conditions
55-107 Paragraphs 718-10-55-60 through 55-63 note that awards may vest based on service conditions,
performance conditions, or a combination of the two. Modifications of market conditions that affect
exercisability or the ability to retain the award are not addressed by this Example. A modification of vesting
conditions is accounted for based on the principles in paragraph 718-20-35-3; that is, total recognized
compensation cost for an equity award that is modified shall at least equal the fair value of the award at the
grant date unless, at the date of the modification, the performance or service conditions of the original award
are not expected to be satisfied. If awards are expected to vest under the original vesting conditions at the date
of the modification, an entity shall recognize compensation cost if either of the following criteria is met:
a. The awards ultimately vest under the modified vesting conditions
b. The awards ultimately would have vested under the original vesting conditions.
55-108 In contrast, if at the date of modification awards are not expected to vest under the original vesting
conditions, an entity should recognize compensation cost only if the awards vest under the modified vesting
conditions. Said differently, if the entity believes that the original performance or service vesting condition is
not probable of achievement at the date of the modification, the cumulative compensation cost related to
the modified award, assuming vesting occurs under the modified performance or service vesting condition, is
the modified award’s fair value at the date of the modification. The following Cases illustrate the application of
those requirements:
a. Type I probable to probable modification (Case A)
b. Type II probable to improbable modification (Case B)
c. Type III improbable to probable modification (Case C)
d. Type IV improbable to improbable modification (Case D).
A modification that changes an award’s vesting conditions is accounted for in the same manner as
any other modification; that is, it is “treated as an exchange of the original award for a new award” in
accordance with ASC 718-20-35-3. Generally, total recognized compensation cost of a modified award
is, at least, the grant-date fair-value-based measure of the original award unless the original award is
not expected to vest under its original terms (i.e., the service condition, the performance condition, or
neither is expected to be met). Therefore, in many circumstances, total recognized compensation cost
attributable to an award that has been modified is (1) the grant-date fair-value-based measure of the
original award for which the vesting conditions have been met (i.e., the number of awards that have
been earned) or is expected to be met and (2) the incremental compensation cost conveyed to the
holder of the award as a result of the modification.
If, on the date of modification, it is expected (probable) that an award will vest under its original vesting
conditions, an entity records compensation cost if it determines that the award ultimately (1) vests
under the modified vesting conditions or (2) would have vested under the original vesting conditions.
For modifications of an award whose vesting was probable under the original vesting conditions, when
determining the ultimate compensation to recognize, an entity would need to consider not only whether
the award actually vests under the modified vesting conditions but also whether the award would have
vested under its original terms. See Type I and Type II modifications in the table below.
276
By contrast, if it is not expected (improbable) on the date of modification that the award will vest under
its original vesting conditions, an entity records compensation cost only if the award vests under
the modified vesting conditions. That is, if the entity did not expect an award to vest on the basis of
the original vesting conditions on the date of modification, it would not have recorded cumulative
compensation cost. If the award vests under the modified vesting conditions, total recognized
compensation cost is based on the number of awards that vest and the fair-value-based measure of
the modified award on the date of modification. The grant-date fair-value-based measure of the original
award is not considered. See Type III and Type IV modifications in the table below.
The various types of modifications, their accounting results, and the bases for recognition of
compensation cost are summarized in the table below (along with cross-references to the applicable
implementation guidance in ASC 718-20-55 and Deloitte guidance).
Basis for Recognition

Accounting of Compensation ASC 718 Deloitte
Type of Modification Result Cost Guidance Guidance
Probable-to-probable Record Grant-date fair-value- ASC 718-20-55- Section 6.3.1

(Type I modification) compensation based measure plus 111 and 55-112
cost if the incremental fair-
award ultimately value-based measure
(1) vests under conveyed on the
the modified modification date, if any
terms or
(2) would have
vested under the
original terms
Probable-to- Record Grant-date fair-value- ASC 718-20-55- See Section 6.3.2

improbable (Type II compensation based measure plus 113 through for an example in
modification) cost if the incremental fair- 55-115 ASC 718-20 (Type
award ultimately value-based measure II modifications
(1) vests under conveyed on the are expected to
the original terms modification date, if any be rare)
or (2) would have
vested under the
modified terms
Improbable-to- Record Modification-date fair- ASC 718-20-55- Section 6.3.3

probable (Type III compensation value-based measure 116 and 55-117
modification) cost if the award
vests under the
modified terms
Improbable-to- Record Modification-date fair- ASC 718-20-55- Section 6.3.4

improbable (Type IV compensation value-based measure 118 and 55-119
modification) cost if the award
vests under the
modified terms
Section 6.3.7 addresses the unit-of-account determination in the assessment of modification type.
277
6.3.1 Probable-to-Probable Modifications
The example below is based on the same facts as in Example 1 in ASC 718-20-55-4 through 55-9 (see
Section 6.1).
ASC 718-20
55-109 Cases A through D are all based on the same scenario: Entity T grants 1,000 share options to each of 10
employees in the sales department. The share options have the same terms and conditions as those described
in Example 1 (see paragraph 718-20-55-4), except that the share options specify that vesting is conditional
upon selling 150,000 units of product A (the original sales target) over the 3-year explicit service period.
The grant-date fair value of each option is $14.69 (see paragraph 718-20-55-9). For simplicity, this Example
assumes that no forfeitures will occur from employee termination; forfeitures will only occur if the sales target
is not achieved. Example 15 (see paragraph 718-20-55-120) provides an additional illustration of a Type III
modification.
55-109A Cases A through D (see paragraphs 718-20-55-111 through 55-119) describe employee awards
because the Cases use the terms and conditions of the employee awards presented as part of Example 1
of this Subtopic (see paragraph 718-20-55-4). However, the principles about determining the cumulative
amount of compensation cost that an entity should recognize because of a modification to an employee award
provided in Cases A through D are the same for nonemployee awards that are modified. Consequently, the
guidance in paragraphs 718-20-55-111 through 55-119 should be applied to determine the cumulative amount
of compensation cost that an entity should recognize because of a modification to a nonemployee award.
55-109B Any additional compensation cost should be recognized by applying the guidance in paragraph
718-10-25-2C. That is, an asset or expense must 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 awards. Additionally, valuation amounts used in the Cases could be
55-110 Cases A through D assume that the options are out-of-the-money when modified; however, that fact is
not determinative in the illustrations (that is, options could be in- or out-of-the-money).
Case A: Type I Probable to Probable Modification

55-111 Based on historical sales patterns and expectations related to the future, management of Entity T
believes at the grant date that it is probable that the sales target will be achieved. On January 1, 20X7, 102,000
units of Product A have been sold. During December 20X6, one of Entity T’s competitors declared bankruptcy
after a fire destroyed a factory and warehouse containing the competitor’s inventory. To push the salespeople
to take advantage of that situation, the award is modified on January 1, 20X7, to raise the sales target to
154,000 units of Product A (the modified sales target). Notwithstanding the nature of the modification’s
probability of occurrence, the objective of this Case is to demonstrate the accounting for a Type I modification.
Additionally, as of January 1, 20X7, the options are out-of-the-money because of a general stock market decline.
No other terms or conditions of the original award are modified, and management of Entity T continues to
believe that it is probable that the modified sales target will be achieved. Immediately before the modification,
total compensation cost expected to be recognized over the 3-year vesting period is $146,900 or $14.69
multiplied by the number of share options expected to vest (10,000). Because no other terms or conditions of
the award were modified, the modification does not affect the per-share-option fair value (assumed to be $8 in
this Case at the date of the modification). Moreover, because the modification does not affect the number of
share options expected to vest, no incremental compensation cost is associated with the modification.
278
55-112 This paragraph illustrates the cumulative compensation cost Entity T should recognize for the modified
award based on three potential outcomes:
a. Outcome 1 — achievement of the modified sales target. In Outcome 1, all 10,000 share options vest
because the salespeople sold at least 154,000 units of Product A. In that outcome, Entity T would
recognize cumulative compensation cost of $146,900.
b. Outcome 2 — achievement of the original sales target. In Outcome 2, no share options vest because
the salespeople sold more than 150,000 units of Product A but less than 154,000 units (the modified
sales target is not achieved). In that outcome, Entity T would recognize cumulative compensation cost of
$146,900 because the share options would have vested under the original terms and conditions of the
award.
c. Outcome 3 — failure to achieve either sales target. In Outcome 3, no share options vest because
the modified sales target is not achieved; additionally, no share options would have vested under
the original terms and conditions of the award. In that case, Entity T would recognize cumulative
compensation cost of $0.
Example 6-8
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options, each with a grant-date
fair-value-based measure of $9. The options vest only if A’s cumulative net income over the succeeding
four-year period is greater than $5 million. Because the options are expected to vest, A begins to recognize
compensation cost on a straight-line basis over the four-year service period. See the journal entries below.
Journal Entries: December 31, 20X1, 20X2, and 20X3

APIC 2,250
To record compensation cost for each of the years ended
December 31, 20X1, 20X2, and 20X3.
On January 1, 20X4, A believes that it is probable that the performance condition will be achieved. To provide
additional retention incentives to the employees for the fourth year of service, A modifies the performance
condition to decrease the cumulative net-income target to $4.5 million. After the modification, A continues to
believe that the options are expected to vest on the basis of the revised cumulative net income target. The
modification does not affect any of the options’ other terms or conditions.
279
If the modified performance condition ($4.5 million) is subsequently met, A will ultimately record total
compensation cost ($9,000) on the basis of the number of options expected to vest (1,000 options if there
are no forfeitures) and the grant-date fair-value-based measure of the options of $9 over the vesting period.2
Because the modification does not affect any of the options’ other terms or conditions, presumably the fair-
value-based measure before and after the modification will be the same. Accordingly, there is no incremental
value conveyed to the holder of the options and, therefore, no incremental compensation cost has to be
recorded in connection with this modification. See the journal entry below.

APIC 2,250
20X4.
Alternatively, if the modified performance condition ($4.5 million) is not subsequently met, the options would
not have vested under either the original or the modified terms. Accordingly, A should not recognize any
cumulative compensation cost for these options (i.e., any previously recognized compensation cost should be
reversed). See the journal entry below.
APIC 6,750
To reverse previously recognized compensation cost.
6.3.2 Probable-to-Improbable Modifications
As discussed in Section 6.1, share-based payment awards are designed to incentivize (rather than
disincentivize) employees. In addition, the legal form of share-based payment awards may prevent
modification without the consent of the grantee. Therefore, a company is not likely to make a change
in a vesting condition that would result in a Type II (probable-to-improbable) modification, and for this
reason, such modifications are rare.
2
ASC 718 requires an entity to record compensation cost if either the original performance condition or the modified performance condition is
met. In this case, since the modified performance target is lower than the original performance target, the attainment of the modified target would
be sufficient to trigger recognition of compensation cost.
280
The example below is based on the same facts as in ASC 718-20-55-109 through 55-110 (see Section
6.3.1).
ASC 718-20
Case B: Type II Probable to Improbable Modification
55-113 It is generally believed that Type II modifications will be rare; therefore, this illustration has been
provided for the sake of completeness. Based on historical sales patterns and expectations related to the future,
management of Entity T believes that at the grant date, it is probable that the sales target (150,000 units of
product A) will be achieved. At January 1, 20X7, 102,000 units of product A have been sold and the options are
out-of-the-money because of a general stock market decline. Entity T’s management implements a cash bonus
program based on achieving an annual sales target for 20X7. The options are neither cancelled nor settled as a
result of the cash bonus program. The cash bonus program would be accounted for using the same accounting
as for other cash bonus arrangements. Concurrently, the sales target for the option awards is revised to 170,000
units of Product A. No other terms or conditions of the original award are modified. Management believes that
the modified sales target is not probable of achievement; however, they continue to believe that the original
sales target is probable of achievement. Immediately before the modification, total compensation cost expected
to be recognized over the 3-year vesting period is $146,900 or $14.69 multiplied by the number of share options
expected to vest (10,000). Because no other terms or conditions of the award were modified, the modification
does not affect the per-share-option fair value (assumed in this Case to be $8 at the modification date).
Moreover, because the modification does not affect the number of share options expected to vest under the
original vesting provisions, Entity T would determine incremental compensation cost in the following manner.
Fair value of modified share option $ 8
Share options expected to vest under modified sales target 10,000
Fair value of modified award $ 80,000
Fair value of original share option $ 8
Share options expected to vest under original sales target 10,000
Fair value of original award $ 80,000
Incremental compensation cost of modification $ —
55-114 In determining the fair value of the modified award for this type of modification, an entity shall use the
greater of the options expected to vest under the modified vesting condition or the options that previously had
been expected to vest under the original vesting condition.
b. Outcome 2 — achievement of the original sales target. In Outcome 2, no share options vest because
the salespeople sold more than 150,000 units of Product A but less than 170,000 units (the modified
sales target is not achieved). In that outcome, Entity T would recognize cumulative compensation cost of
$146,900 because the share options would have vested under the original terms and conditions of the
award.
c. Outcome 3 — failure to achieve either sales target. In Outcome 3, no share options vest because
the modified sales target is not achieved; additionally, no share options would have vested under
the original terms and conditions of the award. In that case, Entity T would recognize cumulative
compensation cost of $0.
281
6.3.3 Improbable-to-Probable Modifications
6.3.1).
ASC 718-20
Case C: Type III Improbable to Probable Modification
believes at the grant date that none of the options will vest because it is not probable that the sales target will
be achieved. On January 1, 20X7, 80,000 units of Product A have been sold. To further motivate the salespeople,
the sales target (150,000 units of Product A) is lowered to 120,000 units of Product A (the modified sales target).
No other terms or conditions of the original award are modified. Management believes that the modified sales
target is probable of achievement. Immediately before the modification, total compensation cost expected to be
recognized over the 3-year vesting period is $0 or $14.69 multiplied by the number of share options expected to
vest (zero). Because no other terms or conditions of the award were modified, the modification does not affect
the per-share-option fair value (assumed in this Case to be $8 at the modification date). Since the modification
affects the number of share options expected to vest under the original vesting provisions, Entity T will
determine incremental compensation cost in the following manner.
Fair value of modified share option $ 8
Share options expected to vest under modified sales target 10,000
Fair value of modified award $ 80,000
Fair value of original share option $ 8
Share options expected to vest under original sales target —
Fair value of original award $ —
Incremental compensation cost of modification $ 80,000
b. Outcome 2 — achievement of the original sales target and the modified sales target. In Outcome 2,
Entity T would recognize cumulative compensation cost of $80,000 because in a Type III modification the
original vesting condition is generally not relevant (that is, the modified award generally vests at a lower
threshold of service or performance).
c. Outcome 3 — failure to achieve either sales target. In Outcome 3, no share options vest because the
modified sales target is not achieved; in that case, Entity T would recognize cumulative compensation
cost of $0.
282
Example 6-9
value-based measure of $9. The options vest only if A’s cumulative net income over the succeeding four-year
period is greater than $5 million. Entity A believes that it is probable that the performance condition will be met
(i.e., the options are expected to vest). Accordingly, A begins to recognize compensation cost on a straight-line
basis over the four-year service period. See the journal entries below.
Journal Entries: December 31, 20X1 and 20X2

APIC 2,250
To record compensation cost for the years ended December 31,
20X1 and 20X2.
On December 31, 20X3, on the basis of its financial performance over the preceding three years, A does not
believe that it is probable that the performance condition will be met (i.e., the options are not expected to vest).
Accordingly, A should reverse any previously recognized compensation cost associated with these options. That
is, because A does not expect the options to vest, cumulative recognized compensation cost as of December
31, 20X3, is zero (0 options expected to vest × $9 grant-date fair-value-based measure):
APIC 4,500
On January 1, 20X4, to restore retention incentives to employees for the fourth year of service, A modifies
the performance condition to decrease the cumulative net income target to $3 million. The fair-value-based
measure of the modified award as of the modification date is $12. After the modification, A believes that the
options are expected to vest on the basis of the revised cumulative net income target. The modification does
not affect any of the award’s other terms or conditions. Accordingly, A will record total compensation cost
($12,000) on the basis of the number of options expected to vest (1,000 options if there are no forfeitures)
and the modification-date fair-value-based measure of the options of $12 over the remaining year of service.
As demonstrated in Case C of Example 14 in ASC 718-20-55-116 and 55-117, since it is improbable that the
options will vest before the modification, the compensation cost is based on the modification-date fair-value-
based measure of the modified options. See the journal entries below.

APIC 12,000
To record compensation cost for the year ended December 31, 20X4.
Alternatively, if the modified performance condition ($3 million) subsequently is not met, the options will
not vest, and A should not recognize any cumulative compensation cost for them (i.e., it should reverse any
compensation cost related to the modified award that was previously recognized in 20X4).
283
The example below illustrates the accounting for an award that is modified to continue vesting in
conjunction with a termination of employment.
ASC 718-20
Example 15: Illustration of a Type III Improbable to Probable Modification

55-120A This Example (see paragraph 718-20-55-121) describes employee awards. However, the principle
provided in paragraph 718-20-55-121 is the same for nonemployee awards that are modified. Consequently,
that guidance should be applied to determine the cumulative amount of compensation cost, if any, that an
entity should recognize because of a modification to a nonemployee award.
55-120B Any additional compensation cost should be recognized by applying the guidance in paragraph
718-10-25-2C. That is, an asset or expense must 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 awards. Additionally, valuation amounts used in this Example could be
55-121 On January 1, 20X7, Entity Z issues 1,000 at-the-money options with a 4-year explicit service condition to
each of 50 employees that work in Plant J. On December 12, 20X7, Entity Z decides to close Plant J and notifies
the 50 Plant J employees that their employment relationship will be terminated effective June 30, 20X8. On June
30, 20X8, Entity Z accelerates vesting of all options. The grant-date fair value of each option is $20 on January
1, 20X7, and $10 on June 30, 20X8, the modification date. At the date Entity Z decides to close Plant J and
terminate the employees, the service condition of the original award is not expected to be satisfied because the
employees cannot render the requisite service. Because Entity Z’s accounting policy is to estimate the number
of forfeitures expected to occur in accordance with paragraph 718-10-35-3, any compensation cost recognized
before December 12, 20X7, for the original award would be reversed. At the date of the modification, the
fair value of the original award, which is $0 ($10 × 0 options expected to vest under the original terms of the
award), is subtracted from the fair value of the modified award $500,000 ($10 × 50,000 options expected to
vest under the modified award). The total recognized compensation cost of $500,000 will be less than the fair
value of the award at the grant date ($1 million) because at the date of the modification, the original vesting
conditions were not expected to be satisfied. If Entity Z’s accounting policy was to account for forfeitures when
they occur in accordance with paragraph 718-10-35-3, then compensation cost recognized before December
12, 20X7, would not be reversed until the award is forfeited. However, Entity Z would be required to assess at
the date of the modification whether the performance or service conditions of the original award are expected
to be satisfied.
6.3.3.1 Modification in Connection With a Termination — Entity Elects to

Estimate Forfeitures
As discussed above, for an entity that has a policy of estimating forfeitures in accordance with ASC
718-10-35-3, any previously recognized compensation cost is reversed if a grantee is expected to
terminate employment or a nonemployee arrangement to provide goods or services and the vesting
requirements in an award are no longer expected to be met. If the award is modified to accelerate
vesting, compensation cost will be recognized on the basis of the modification-date fair-value-based
measure of the award.
284
Example 6-10
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options to its CEO, each with a grant-
date fair-value-based measure of $9. The options vest if the CEO is employed for a five-year period (cliff vesting).
In addition, A has a policy of estimating forfeitures, and it recognizes compensation cost on a straight-line basis
over the five-year service period. Entity A records the following journal entry each year:
Journal Entry

APIC 1,800
To record compensation cost for each year during the service period.
On July 1, 20X3, the CEO decides to terminate employment. The CEO and A reach a severance agreement
that permits the CEO to vest in the options upon termination as long as the CEO continues to provide service
through December 31, 20X3, while A searches for a new CEO. On July 1, 20X3, it is no longer probable that
the service condition of the original award will be met. Accordingly, A should reverse previously recognized
compensation cost of $4,500 associated with the original options (1,000 options × $9 grant-date fair-value-
based measure ÷ 5-year vesting period × 2.5 years of service). That is, because A does not expect the options to
vest, cumulative recognized compensation cost as of July 1, 20X3, should be zero (0 options expected to vest ×
$9 grant-date fair-value-based measure). See the journal entry below.
Journal Entry: July 1, 20X3
APIC 4,500
The fair-value-based measure of the modified award as of the modification date is $15. The modification does
not affect any of the other terms or conditions of the award, and A believes that the CEO will provide the
requisite service period of six months. Accordingly, A will record total compensation cost of $15,000 on the basis
of the number of options expected to vest (1,000 options) and the modification-date fair-value-based measure of
the options of $15 over the remaining service period (i.e., six months). Since it is improbable that the options will
vest before the modification and probable that the options will vest after the modification, compensation cost is
based on the modification-date fair-value-based measure of the modified options. See the journal entry below.

APIC 15,000
To record compensation cost for the six-month period ended
December 31, 20X3.
285
6.3.3.2 Modification in Connection With a Termination — Entity Elects to Account

for Forfeitures When They Occur
As discussed in Section 3.4.1, ASC 718-10-35-3 permits an entity to elect to account for forfeitures as
they occur. However, the vesting of an award upon the satisfaction of a service condition may become
improbable as a result of a planned future termination of employment or a nonemployee arrangement
to provide goods or services (e.g., a plant shutdown or executive separation agreement). If the award
is modified on the termination date to accelerate vesting, previously recognized compensation cost
is not reversed until the termination date, and compensation cost will continue to be recognized on
the basis of the original award’s grant-date fair-value-based measure until the termination date. On
the termination and modification date, previously recognized compensation cost is reversed, and
compensation cost is recognized on the basis of the modified award’s modification-date fair-value-based
measure.
However, an award may be modified before termination to accelerate vesting upon the planned future
termination event. On the basis of discussions with the FASB staff, there are two acceptable views
regarding the accounting for these improbable-to-probable modifications:
• View 1 — The original award is substantively forfeited upon modification. Because the award is
modified and will be vested upon termination (i.e., the original award no longer exists and has
been replaced by a new award), forfeiture does not occur on the termination date. In addition,
the guidance in ASC 718-10-35-1D and ASC 718-10-35-3 allows entities to elect, as a policy, to
account for forfeitures when they occur, but it was not intended to change the accounting for
modifications. Therefore, previously recognized compensation cost for the original award should
be reversed on the modification date. Compensation cost for the modified award should be
determined on the basis of the modification-date fair-value-based measure and recognized over
the employee’s remaining service period or nonemployee’s vesting period.
• View 2 — A forfeiture of the original award has not occurred upon modification (i.e., since
employment has not yet been terminated or the nonemployee arrangement has not yet been
terminated, the original award is not forfeited). Previously recognized compensation cost should
not be reversed on the modification date. Instead, the modification-date fair-value-based
measure of the modified award less the previously recognized compensation cost should be
recognized over the employee’s remaining service period or nonemployee’s vesting period. If the
modification-date fair-value-based measure of the modified award is lower than the previously
recognized compensation cost, no further compensation cost is recognized, and that difference
should be reversed upon termination when forfeiture of the original award has occurred.
If an award whose vesting becomes improbable as a result of a planned future termination is not
modified, previously recognized compensation cost should not be reversed, and compensation cost
should continue to be recognized until the award is forfeited (i.e., upon termination). Upon termination,
previously recognized compensation cost is reversed.
286
Example 6-10A
Assume the same facts as in Example 6-10, except that Entity A has a policy of recognizing forfeitures when
they occur.
If A applies View 1 above, it would record the same journal entries as it did in Example 6-10.
If it applies View 2, it would recognize compensation cost on a straight-line basis over the five-year service
period (as it did in Example 6-10) and record the following journal entry each year:
Journal Entry

APIC 1,800
To record compensation cost for each year during the service period.
On July 1, 20X3, the award is modified. Because the original award has not been forfeited, previously recognized
compensation cost is not reversed. Entity A will recognize the modification-date fair-value-based measure
of the modified award of $15,000 (1,000 options × $15 modification-date fair-value-based measure) less the
previously recognized compensation cost of $4,500 (1,000 options × $9 grant-date fair-value-based measure ÷
5-year vesting period × 2.5 years of service) over the remaining service period (i.e., six months). See the journal
entry below.

APIC 10,500
To record compensation cost for the six-month period ended
December 31, 20X3.
6.3.4 Improbable-to-Improbable Modification
6.3.1).
ASC 718-20
Case D: Type IV Improbable to Improbable Modification
believes that at the grant date it is not probable that the sales target will be achieved. On January 1, 20X7,
80,000 units of Product A have been sold. To further motivate the salespeople, the sales target is lowered to
130,000 units of Product A (the modified sales target). No other terms or conditions of the original award are
modified. Entity T lost a major customer for Product A in December 20X6; hence, management continues to
believe that the modified sales target is not probable of achievement. Immediately before the modification,
total compensation cost expected to be recognized over the 3-year vesting period is $0 or $14.69 multiplied by
the number of share options expected to vest (zero). Because no other terms or conditions of the award were
modified, the modification does not affect the per-share-option fair value (assumed in this Case to be $8 at the
modification date). Furthermore, the modification does not affect the number of share options expected to
vest; hence, there is no incremental compensation cost associated with the modification.
287
recognize cumulative compensation cost of $80,000 (10,000 × $8).
b. Outcome 2 — achievement of the original sales target and the modified sales target. In Outcome 2,
Entity T would recognize cumulative compensation cost of $80,000 because in a Type IV modification the
original vesting condition is generally not relevant (that is, the modified award generally vests at a lower
threshold of service or performance).
c. Outcome 3 — failure to achieve either sales target. In Outcome 3, no share options vest because the
modified sales target is not achieved; in that case, Entity T would recognize cumulative compensation
cost of $0.
Share-based payment awards may contain a performance condition that requires an IPO to occur
before the awards can vest. Compensation cost for such awards typically is not recognized before the
IPO because an IPO generally is not considered probable until it occurs (see Section 3.4.2.1). Before and
in contemplation of the occurrence of an IPO, entities may modify the terms and conditions of these
types of awards. For example, an award that vests upon an IPO and a specified service period could
be modified to reduce the specified service period. Although the modification is made in anticipation
of the IPO, at the time of the modification, compensation cost is not recognized because the IPO
has not yet occurred (i.e., it is still not probable that the award will vest). However, the effects of the
modification are measured on the modification date. Since it is not probable that the original award
and the modified award will vest, the modification is considered a Type IV improbable-to-improbable
modification. As discussed above, when it is not probable as of the modification date that an award will
vest on the basis of its original terms, the original grant-date fair-value-based measure of compensation
cost is disregarded once the modification is made. Instead, in accordance with ASC 718-20-55-108,
any compensation cost recognized will be based on a new fair-value-based measure determined on
the modification date on the basis of the terms of the compensation cost. Once an IPO occurs, the
compensation cost will be recognized on the basis of the modification-date fair-value-based measure.
Many modifications are made before an IPO but are not effective unless the IPO occurs. While the date
on which a contingent modification is made is generally the modification date for compensation cost
measurement purposes, the accounting consequence may not be recognized until the IPO’s effective
date if the modification is contingent on the IPO’s occurrence. For example, an award could be modified
to increase the quantity of underlying shares upon a successful IPO. In this circumstance, any additional
compensation cost (as determined on the modification date) would not be recognized until the IPO is
effective.
In addition, there could be circumstances in which changes associated with an award that are not
modifications result in accounting consequences. For example, an entity could grant an equity-classified
award with a repurchase feature that causes the award to be liability-classified. If the original terms
contain a provision that the repurchase feature will expire upon an IPO, however, the award would be
reclassified from liability to equity upon the IPO. See Section 5.9 for further discussion of changes in
classification as a result of changes in probable settlement outcomes.
288
Example 6-11
value-based measure of $9. The options vest only if A’s cumulative net income over the succeeding four years
is greater than $5 million and A completes an IPO. Entity A believes that it is probable that the net income
performance condition will be met. However, because an IPO is generally not considered probable until it
occurs (see Section 3.4.2.1), A does not recognize any compensation cost.
On January 1, 20X4, because its financial performance has deteriorated, A modifies the net income
performance condition to decrease the cumulative net income target to $4 million. The modification does not
affect any of the options’ other terms or conditions. The fair-value-based measure of the modified options as of
the modification date is $12.
Even though A expects the revised net income target to be met, an IPO has not yet occurred and is therefore
still not considered probable (i.e., the options are not expected to vest). Accordingly, total recognized
compensation cost for the modified award is zero (0 options expected to vest × $12 modification-date fair-
value-based measure). As demonstrated in Case D of Example 14 in ASC 718-20-55-118 and 55-119, since it is
improbable that the options will vest before the modification, compensation cost is based on the modification-
date fair-value-based measure of the modified award.
Subsequently, if the modified net income performance condition ($4 million net income) is met and an IPO
occurs, the options will vest. Accordingly, A should recognize compensation cost of $12,000 on the basis of the
number of options vested (1,000 options if there are no forfeitures) and the fair-value-based measure of the
modified options on the date of modification ($12). See the journal entry below.
Journal Entry

APIC 12,000
To record compensation cost for the fully vested options.
Example 6-12
value-based measure of $9. The options vest only if (1) A completes an IPO (performance condition) and
(2) a specified target IRR to shareholders is achieved (market condition). Both conditions must be met for the
employees to earn the awards. Compensation cost should not be recognized unless it is probable that the
performance condition will be met. Because an IPO generally is not considered probable until it occurs, A does
not recognize any compensation cost.
On January 1, 20X2, A modifies the market condition by lowering the IRR target. On the modification date, the
fair-value-based measure of each of the original options is $10, and the fair-value-based measure of each of
the modified options is $13. The fair-value-based measure will incorporate the IRR target because a market
condition is not a vesting condition. When an award contains a performance condition and it is not probable
that the performance condition will be met before a modification, the original grant-date fair-value-based
measure of compensation cost is disregarded, and only the modification-date fair-value-based measure
is considered. Because an IPO has not yet occurred and is therefore still not considered probable (i.e., the
options are not expected to vest), total recognized compensation cost for the modified award is zero (0 options
expected to vest × $13 modification-date fair-value-based measure).
289
Entity A would ultimately recognize compensation cost on the basis of the modification-date fair-value-based
measure of the modified award only when it becomes probable that the performance condition will be met (i.e.,
upon the occurrence of an IPO). On April 13, 20X4, A completes an IPO. Because the performance condition has
now been met, A should recognize compensation cost of $13,000 on the basis of the number of options vested
(1,000 options if there are no forfeitures) and the fair-value-based measure of the modified options on the date
of modification ($13) irrespective of whether the IRR target is achieved. See the journal entry below.
Journal Entry: April 13, 20X4

APIC 13,000
To record compensation cost for the fully vested options.
6.3.5 Modifications to Accelerate Vesting of Deep Out-of-the-Money Stock

Options
At-the-money stock option awards may become out-of-the-money awards because of declines in the
value of the underlying shares. If the underlying shares’ value is severely depressed relative to the
exercise price, the awards are considered “deep out-of-the-money.” If deep out-of-the-money stock
option awards no longer offer sufficient retention motivation to grantees, entities may contemplate
accelerating their vesting.
As indicated in ASC 718-10-55-67, the acceleration of the vesting of a deep out-of-the-money award
granted to an employee is not substantive because the explicit service period is replaced with a derived
service period (see Section 3.6.3 for a discussion of derived service periods). Accordingly, any remaining
unrecognized compensation cost should not be recognized immediately, and an entity should generally
continue to recognize such cost over the remaining original requisite service period.
To be an in-the-money award, the stock price of the award must, during the derived service period,
increase to a level above the stock price on the grant date. Accordingly, the employee must continue to
work for the entity during the derived service period to receive any benefit from the stock option award
because it is customary for awards to have features that limit exercisability upon termination (i.e., the
term of the option typically truncates, such as 90 days after termination).
ASC 718 does not provide guidance on determining whether an accelerated stock option award is deep
out-of-the-money. An entity will therefore need to use judgment and may consider, among other factors,
those that affect the value of the award (e.g., volatility of the underlying stock, exercise price, risk-free
rate) and time it will take for the award to become at-the-money. In addition, an entity may calculate the
derived service period of the modified award and compare it with the original remaining service period
to determine whether the modification is substantive. If the derived service period approximates or is
longer than the original remaining service period, the modification would most likely not be substantive.
In certain situations, it may be clear that the award is deep out-of-the-money.
290
While the guidance in ASC 718-10-55-67 addresses employee awards, it should be applied by analogy to
similar types of nonemployee awards.
Example 6-13
On January 1, 20X1, Entity A granted 100 at-the-money stock options to its employees, each with a grant-date
fair-value-based measure of $10. The awards vest at the end of the fourth year of service (cliff vesting) and have
an exercise price of $20. Accordingly, A recognizes compensation cost ratably over the four-year service period.
On January 1, 20X3, when the stock options are deemed to be deep out-of-the-money, A modifies the awards
to accelerate their remaining service period. Because the awards are considered deep out-of-the-money,
the acceleration of their remaining service period is not substantive. Accordingly, A should not recognize the
remaining unrecognized compensation cost immediately on January 1, 20X3. Rather, A should continue to
recognize the remaining unrecognized compensation cost over the original requisite service period. That is,
A should continue recognizing compensation cost as if the modification never occurred and recognize the
remaining $500 ($10 grant-date fair-value-based measure × 100 awards × half of the original requisite service
period) in compensation cost over the remaining two years of the original requisite service period (recognizing
$250 in each of 20X3 and 20X4).
6.3.6 Modification of the Employee’s Requisite Service Period

The accounting for the modification of a share-based payment award’s requisite service period is based
on whether the modified requisite service period is shorter or longer than the original requisite service
period.
6.3.6.1 Modification to Reduce the Employee’s Requisite Service Period of an

Award
If an entity modifies the requisite service period of a share-based payment award and the modified
award’s requisite service period is shorter than the original award’s requisite service period, the entity
should recognize compensation cost over the remaining portion of the modified award’s requisite
service period. The fair-value-based measure of the modified award would most likely be the same or
less than the fair-value-based measure of the original award immediately before modification because
the modification only affects the service period of the award. Vesting conditions are not directly factored
into the fair-value-based measure of an award. In addition, if the award is a stock option award, the
fair-value-based measure may be less than the fair-value-based measure of the original award because
a shorter vesting period may result in a shorter expected term, as discussed in Section 6.1. Accordingly,
there is no incremental value conveyed to the holder of the award, and no incremental compensation
cost is recognized in connection with the modification.
However, the entity may consider whether the reduction in the requisite service period affects the
number of awards that are expected to vest. If, as a result of the modification, the entity expects
additional awards to vest, those awards may be accounted for as an improbable-to-probable
modification.3 For the awards that were originally expected to vest, no incremental compensation cost is
recognized in connection with the modification, as discussed above. For the additional awards expected
to vest as a result of the modification, the entity will record compensation cost on the basis of (1) the
incremental number of awards that are now expected to vest and (2) the modification-date fair-value-
3
An entity that modifies a group of awards granted to a number of grantees may instead choose to consider each grantee’s awards as the unit
of account when determining whether the awards are expected to vest and the type of modification accounting to apply. When applying this
approach, the entity may conclude that each individual’s awards were expected to vest before the modification and are accounted for as a
probable-to-probable modification. That is, even if a few grantees were expected to forfeit the original awards as a result of normal turnover, the
entity may account for the entire modification as a probable-to-probable modification. However, if an entity’s policy is to estimate forfeitures when
recognizing compensation cost, and the percentage of all modified awards that are expected to vest increases (i.e., the entity’s forfeiture rate is
reduced), additional compensation cost will be recognized for those awards on the basis of their original grant-date fair-value-based measure.
291
based measure of the awards over the remaining portion of the requisite service period of the modified
awards. See Section 6.3.3 for a discussion of improbable-to-probable modifications.
Example 6-14
value-based measure of $20. The options vest at the end of the fourth year of service (cliff vesting). In addition,
A has a policy of estimating forfeitures and estimates that 10 percent of the options will be forfeited.
Over the first year of service, A records $4,500 of cumulative compensation cost, or (1,000 options × 90 percent
of options expected to vest) × $20 grant-date fair-value-based measure × 25 percent for one of four years of
services rendered. On January 1, 20X2, A modifies the options to reduce the requisite service period from four
years to three years. The fair-value-based measure of the modified options as of the modification date is $12.
Because the modification only affects the service period of the options, and the service period is shorter, the
fair-value-based measure of the modified options would most likely be equal to or less than the fair-value-
based measure of the original options immediately before modification. Accordingly, there is no incremental
value conveyed to the holder of the award.
However, because of the reduced requisite service period, A now expects 95 percent of the options to vest.
Accordingly, A will recognize the remaining unrecognized compensation cost for the 900 options originally
expected to vest — (1,000 options × 90 percent of options originally expected to vest) × $20 grant-date fair-
value-based measure – $4,500 amount previously recognized = $13,500 — over the remainder of the modified
requisite service period (two years). For the 50 options now expected to vest as a result of the modification, A
may recognize $600 of incremental compensation cost (50 options expected to vest × $12 modification-date
fair-value-based measure) over the remainder of the modified requisite service period (two years).
6.3.6.2 Modification to Increase the Employee’s Requisite Service Period of an

Award
If the requisite service period of a modified award is longer than the requisite service period of the
original award and, both before and after the modification, it is probable that the awards will vest (Type
I or probable-to-probable modification), an entity may make an accounting policy choice to use either
of the following methods (both were discussed by the Statement 123(R) Resource Group at its May 26,
2005, meeting; see Section 6.3.1 for a discussion of probable-to-probable modifications):
• The unrecognized compensation cost remaining from the original award would be recognized
over the remaining portion of the requisite service period of the original award. The incremental
compensation cost, if any, as a result of the modification would be recognized over the
remaining portion of the requisite service period of the modified award. See Method 1 in
Example 6-15.
• The unrecognized compensation cost remaining from the original award plus the incremental
compensation cost, if any, as a result of the modification would be recognized in its entirety over
the remaining portion of the requisite service period of the modified award. See Method 2 in
Example 6-15. (Note, however, that if an employee is not expected to render service over the
new requisite service period but is expected to render service over the original requisite service
period, the unrecognized compensation cost remaining from the original award would be
recognized over the remaining portion of the original award’s requisite service period.)
Regardless of the method chosen, it must be applied consistently and disclosed in accordance with ASC
235-10 if it is material to the financial statements.
292
Under either method, if the employee does not remain employed for the original award’s requisite service
period, any previously recognized compensation cost should be reversed. However, if the employee
remains employed for the original award’s requisite service period but terminates employment before
the modified award’s requisite service period, all compensation cost associated with the original award
should be recognized. Under Method 1, all compensation cost associated with the original award would
already have been recognized. Under Method 2, all compensation cost associated with the original award
should be immediately recognized. However, under either method, any previously recognized incremental
compensation cost associated with the modified award should be reversed. As a result of a modification,
the total recognized compensation cost attributable to an award is generally required to be at least equal
to the grant-date fair-value-based measure of the original award if the original service or performance
condition is met or is expected to be met as of the modification date.
Example 6-15
Assume the same facts as in Example 6-14, except that on January 1, 20X2, Entity A modifies the options to
(1) reprice them (i.e., lower the exercise price to equal the market price of A’s shares) and (2) lengthen the
requisite service period from four years to five years. The fair-value-based measure of the original options
immediately before the modification is $12, and the fair-value-based measure of the modified options is $16.
For simplicity, assume that the extension of the service period does not affect forfeitures (90 percent expected
to vest).
On the modification date, A computes the incremental compensation cost as $3,600, or ($16 fair-value-based
measure of modified options – $12 fair-value-based measure of original options immediately before the
modification) × 900 options. Accordingly, A will recognize the total remaining unrecognized compensation cost
of $17,100 ($13,500 of unrecognized compensation cost from the original options plus $3,600 in incremental
compensation cost from the modification) by using one of two acceptable methods:
• Method 1 — Entity A will recognize the unrecognized compensation cost remaining from the original
award of $13,500 over the remaining portion of the requisite service period of the original award (three
years). The incremental compensation cost of $3,600 as a result of the modification will be recognized
over the remaining portion of the requisite service period of the modified award (four years).
• Method 2 — Entity A will recognize $17,100 ratably over the remaining portion of the requisite service
period of the modified award (four years).
6.3.7 Determining the Unit of Account When Assessing the Type of

Modification
A share-based payment award may contain a performance condition under which a different number of
shares vest depending on various outcomes of a performance target (e.g., an EPS growth percentage).
ASC 718-10-25-20 requires compensation cost to be accrued on the basis of the probable outcome of
an award’s performance conditions; however, ASC 718 prohibits recognition of compensation cost for
a performance condition or conditions whose achievement is not probable. The interrelationship of
the performance targets is a key part of the unit-of-account assessment. An entity would only accrue
compensation cost associated with the number of awards whose vesting is probable at the end of
each reporting period. If a modification is made to one or more performance targets that results in
the vesting of a different number of awards, an entity should consider whether to apply modification
accounting to the award in tranches (under ASC 718-20-35-2A) on the basis of each tranche’s probability
of vesting immediately before and after the performance target or targets are modified. The example
below illustrates such a scenario.
293
Example 6-15A
On January 1, 20X1, Entity A grants stock options to an employee. The stock options (1) include a performance
condition that is based on a three-year cumulative EBITDA growth target and (2) have a grant-date fair-value-
based measure of $6. The number of equity-classified stock options that will vest at the end of the third year of
employment (cliff vesting) varies depending on the EBITDA growth target achieved, as defined below:
EBITDA Growth
Tranche Target Options
1 100% 1,000
2 110% 1,100
3 120% 1,200
During 20X1 and 20X2, A believes that it is probable that the 100 percent EBITDA growth target will be met at
the end of 20X3 but not probable that the 110 percent growth target will be met. Accordingly, A recognizes
compensation of $2,0004 in 20X1 and 20X2 on the basis of its conclusion that Tranche 1 will be the probable
outcome.
In early 20X3, A decides to lower the EBITDA growth target needed for vesting under each tranche to the
following:
EBITDA Growth
Tranche Target Options
1 95% 1,000
2 105% 1,100
3 115% 1,200
The fair-value-based measure of each option on the day of modification is $7. On the date of the modification,
A believes that it is (1) probable that the 105 percent EBITDA growth target will be met at the end of 20X3 under
the modified terms but (2) not probable that the 110 percent growth target will be met under the original
terms. This represents an improbable-to-probable modification for the incremental 100 options whose vesting
is now probable on the basis of the modification (1,100 options in total are now expected to vest). During
20X3, A will accrue compensation cost for the Tranche 1 awards expected to vest by using the $6 original
grant-date fair-value-based measure because vesting of the Tranche 1 awards was probable before and after
the modification and there is no incremental compensation cost as a result of the modification (the fair-value-
based measure of each option immediately before and after the modification is $7). For Tranche 2, A will accrue
compensation cost beginning on the modification date for the 100 incremental options expected to vest by
using the $7 fair value of the options on the day of the modification ($700 in incremental compensation cost
over the remaining requisite service period).
Vesting of the Tranche 3 awards was improbable before the modification and continues to be improbable
after it. Since it is not probable that the original award and the modified award will vest under Tranche 3, the
modification is considered a Type IV improbable-to-improbable modification. If the 115 percent EBITDA growth
target subsequently become probable, any compensation cost recognized will be based on the $7 fair-value-
based measure for each option determined on the modification date.
4
Calculated as [($6 × 1,000 options) ÷ by 3 years].
294
6.4 Modification of Factors Other Than Vesting Conditions

Modifications may be made to an award that do not affect its vesting conditions (i.e., its service or
performance conditions). If modification accounting is required for such changes (see Section 6.1 for
circumstances in which modification accounting is not required), the same principles apply as those
discussed in Section 6.3.
6.4.1 Modification of a Market Condition

The modification of an award’s market condition does not directly affect the probability that the award
will be earned. Unlike a service or a performance condition, a market condition is not a vesting condition
but rather is factored into the award’s fair-value-based measure (see Section 3.5). However, the
modification could indirectly affect the probability that the award will be earned if there is a change in a
derived service period.
The determination of whether an award will vest depends on whether the grantee meets any service
or performance conditions. Accordingly, if the original award is expected to vest at the time of the
modification, incremental compensation cost is computed as the excess of the fair-value-based measure
of the modified award on the date of modification over the fair-value-based measure of the original
award immediately before the modification.
Example 6-16
On January 1, 20X1, Entity A granted 1,000 at-the-money employee stock options, each with a grant-date fair-
value-based measure of $5 and a derived service period of five years. The options have an exercise price of
$12 and become exercisable only if the market price of A’s shares reaches $20. In addition, A has a policy of
estimating forfeitures, and it estimates that 15 percent of the options will be forfeited because the employees
will terminate employment before the end of the derived service period.
Over the first year of service, A records $850 of cumulative compensation cost, or (1,000 options × 85 percent
of options expected to vest) × $5 grant-date fair-value-based measure × 20 percent for one of five years of
services rendered. On January 1, 20X2, because of a significant decline in the market price of A’s shares, A
modifies the options to be exercisable when the market price of A’s shares reaches $15. The fair-value-based
measure of the original options immediately before modification is $3, and the fair-value-based measure of
the modified options is $4. In addition, the derived service period of the modified options is three years. As a
result of the reduction in the derived service period, A expects additional options to vest. Accordingly, A revises
its forfeiture estimate from 15 percent to 10 percent and computes the incremental compensation cost as a
result of modifying the options’ market condition as follows:
Fair-value-based measure of the modified options [$4 modification-date fair-value-based $ 3,600

measure × (1,000 options × 90 percent of options expected to vest)]
Fair-value-based measure of the original options [$3 modification-date fair-value-based 2,550

measure × (1,000 options × 85 percent of options expected to vest)]
Incremental compensation cost $ 1,050*

* The modification includes both (1) a Type I probable-to-probable modification for 85 percent of
the awards and (2) a Type III improbable-to-probable modification of 5 percent of the awards.
The total compensation cost to be recognized over the remaining derived service period of the modified
options (three years) of $4,450 is the unrecognized compensation cost from the original options of $3,400 —
(1,000 options × 85 percent of options expected to vest) × $5 grant-date fair-value-based measure – $850
previously recognized — plus the incremental compensation cost resulting from the modification of the
options’ market condition of $1,050 (determined above).
295
6.4.2 Modification of Stock Options During Blackout Periods

In certain instances, grantees (including grantees who are no longer employed or are no longer
providing goods or services) may not be able to exercise their stock options because of blackout periods
imposed by the entity or others. Blackout periods may be imposed because (among other reasons):
• The terms of an award require such periods (e.g., to restrict the selling of an entity’s securities
close to its earnings releases).
• The entity’s registration statements on Form S-8 are temporarily suspended because its filing
requirements under the Securities Exchange Act of 1934 are not current.
• An entity’s stock has been delisted.

If grantees have vested options that will expire during a blackout period, sometimes entities will (even
though they have no obligation to do so) extend the options’ term to give such grantees the ability to
exercise the options after the blackout period is over (or provide other assets in lieu of the options). The
extension of the options’ contractual term should be accounted for as a modification. If, at the time of the
modification, the original options are not exercisable because of a blackout period and the entity is not
obligated to settle the option in cash or other assets, the options have no value to the holders. An entity
may wish to seek the opinion of legal counsel in determining whether it is obligated to settle in cash or
other assets. In accordance with ASC 718-20-35-3, the incremental compensation cost is the excess of
the fair-value-based measure of the modified award on the date of modification over the fair-value-based
measure of the original award immediately before the modification. Since the original options’ value is zero,
the incremental value would be the fair-value-based measure of the modified options because the entity
has, in substance, replaced worthless options with options that the grantees can exercise in the future.
Further, because the award is fully vested, the compensation cost would be recognized in full on the date
of the modification.
6.5 Equity Restructuring
Equity Restructuring
A nonreciprocal transaction between an entity and its shareholders that causes the per-share fair value of the
shares underlying an option or similar award to change, such as a stock dividend, stock split, spinoff, rights
offering, or recapitalization through a large, nonrecurring cash dividend.
ASC 718-20
Equity Restructuring or Business Combination

35-6 Exchanges of share options or other equity instruments or changes to their terms in conjunction with an
equity restructuring or a business combination are modifications for purposes of this Subtopic. An entity shall
apply the guidance in paragraph 718-20-35-2A to those exchanges or changes to determine whether it shall
account for the effects of those modifications. Example 13 (see paragraph 718-20-55-103) provides further
guidance on applying the provisions of this paragraph. See paragraph 718-10-35-10 for an exception.
Equity Restructuring
55-2 In accordance with paragraph 718-20-35-6, an entity shall apply the guidance in paragraph 718-20-35-2A
to exchanges of share options or other equity instruments or changes to their terms in conjunction with an
equity restructuring to determine whether it shall account for the effects of those modifications as described
in paragraphs 718-20-35-3 through 35-9. Example 13 (see paragraph 718-20-55-103) provides additional
guidance on accounting for modifications of awards in the context of equity restructurings.
296
6.5.1 Antidilution Provisions
An equity restructuring is a nonreciprocal transaction between an entity and its shareholders that
causes a change in the per-share fair value of the shares underlying an award (e.g., stock dividend,
stock split, spin-off). Exchanges of stock options or other equity instruments or changes to their terms
in conjunction with an equity restructuring are modifications. However, the effect of such modifications
depends on whether an adjustment is made in accordance with an existing nondiscretionary antidilution
provision. A nondiscretionary provision is clear and measurable and requires the entity to take action.
By contrast, a discretionary provision may be broad or subjective, and it allows but does not require the
entity to take action.
If the terms of the original award do not include an antidilution provision and an entity subsequently
adds an antidilution provision but does not contemplate an equity restructuring, the fair-value-based
measure of the award would generally remain the same. Accordingly, as long as there are no other
changes to the award that would affect vesting or classification, the entity does not apply modification
accounting. If the entity contemplates an equity restructuring, however, it applies modification
accounting and may need to recognize significant incremental compensation cost.
In addition, upon an equity restructuring, it is not uncommon for an entity to make grantees “whole”
(in accordance with a preexisting nondiscretionary antidilution provision) on an intrinsic-value basis
when the awards are stock options. In certain circumstances, the fair-value-based measure of modified
stock options could change as a result of the equity restructuring even if the intrinsic value remains the
same. Under ASC 718-20-35-2A, an entity compares the intrinsic value before and after a modification in
determining whether to apply modification accounting only “if such an alternative measurement method
is used”; thus, if an entity uses a fair-value-based measure to calculate and recognize compensation cost
for its share-based payment awards, it would still be required to apply modification accounting when the
fair-value-based measure has changed, even if the intrinsic value is the same immediately before and
after the modification.
An entity may adjust an award by making a cash payment to the holder, particularly in circumstances
in which the equity restructuring is in the form of a large, nonrecurring cash dividend. Although the
authoritative guidance does not explicitly address cash payments made in conjunction with an equity
restructuring, transactions such as these are treated as a modification or a partial settlement (or a
combination of both). See Section 6.10.2.
6.5.1.1 Original Award Contains a Nondiscretionary Antidilution Provision

To determine whether incremental compensation cost should be recognized, an entity should compare
the fair-value-based measure of the modified award with the fair-value-based measure of the original
award (on the basis of the stated antidilution terms in the award) immediately before the modification.
See below for illustrations of original awards that contain either a nondiscretionary (Example 6-17) or
a discretionary (Example 6-19) antidilution provision. If the award is modified pursuant to a preexisting
nondiscretionary antidilution provision, modification accounting is not required if the fair-value-
based measure, vesting conditions, and classification are the same immediately before and after
the modification. Further note that the accounting for a modification of an award with a preexisting
nondiscretionary antidilution provision may result in both (1) a settlement and (2) a modification that
changes the award’s classification to a liability (see Example 6-31A).
297
An entity should carefully review the terms of its awards to determine whether an adjustment is required
if an equity restructuring occurs. In certain circumstances when such an adjustment is required, the
entity may be permitted to choose how to make it (e.g., the entity may be allowed to determine how it
adjusts the exercise price or quantity of stock options). As long as an equitable adjustment is required
by the award, an entity may conclude that the antidilution provision is nondiscretionary, even if the entity
has some discretion in determining how to make the adjustment. When it is not clear that an equitable
adjustment is required, an entity should consider whether the holder of the award could enforce
an antidilution adjustment. The entity may need to obtain the opinion of legal counsel to make that
determination.
ASC 718-20
Example 13: Modifications Due to an Equity Restructuring

55-103 As a reminder, exchanges of share options or other equity instruments or changes to their terms in
conjunction with an equity restructuring are considered modifications for purposes of this Topic. The following
Cases illustrate the guidance in paragraph 718-20-35-6:
a. Original award contains antidilution provisions (Case A).
b. Original award does not contain antidilution provisions (Case B).
c. Original award does not contain an antidilution provision but is modified on the date of equity
restructuring (Case C).
Case A: Original Award Contains Antidilution Provisions

55-104 In this Case, assume an award contains antidilution provisions. On May 1 there is an announcement of
a future equity restructuring. On October 12 the equity restructuring occurs and the terms of the award are
modified in accordance with the antidilution provisions. In this Case, the modification occurs on October 12
when the terms of the award are changed. The fair value of the award is compared pre- and postmodification
on October 12. The calculation of fair value is necessary to determine whether there is any incremental value
transferred as a result of the modification, and if so, that incremental value would be recognized as additional
compensation cost. If there is no change in fair value, vesting conditions, or the classification of the award, the
entity would not account for the effect of the modification (see paragraph 718-20-35-2A).
Example 6-17
Stock Split When the Original Award Contains a Nondiscretionary Antidilution Provision
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options with a grant-date fair-value-
based measure of $6 and an exercise price of $10. The options vest at the end of the third year of service (cliff
vesting) and contain a nondiscretionary antidilution provision. On July 1, 20X2, A announces a two-for-one stock
split and that a nondiscretionary antidilution provision will apply to each of the options. The nondiscretionary
antidilution provision that existed in the original terms of the options requires an adjustment to preserve the
value of the options after the stock split. Because the antidilution provision is not discretionary and already
existed, A is not likely to apply modification accounting on July 1, 20X2, when A announces the two-for-one
stock split, because modification accounting is not applied if the fair-value-based measure of the options
immediately before and after the stock split is the same, and there are no changes to the vesting conditions or
classification of the options. Accordingly, A records no incremental compensation cost.
298
6.5.1.2 Modification to Add a Nondiscretionary Antidilution Provision in

Contemplation of an Equity Restructuring
An adjustment to the terms of an award to maintain the holder’s value in response to an equity
restructuring may trigger the recognition of significant compensation cost if (1) the adjustment is not
required under the existing terms of the award and (2) the provision that requires an adjustment
is added in contemplation of an equity restructuring. Note that the addition of a nondiscretionary
antidilution provision to a stock option plan could result in unintended tax consequences and could be
considered a disqualifying event of an ISO. An entity should consult with its tax professional regarding
the tax implications of making changes to its stock option plans.
ASC 718-20
Example 13: Modifications Due to an Equity Restructuring

Case B: Original Award Does Not Contain Antidilution Provisions
55-105 In this Case, the original award does not contain antidilution provisions. On May 1 there is an
announcement of a future equity restructuring. On July 26 the terms of an award are modified to add
antidilution provisions in contemplation of an equity restructuring. On September 30 the equity restructuring
occurs. In this Case, there are two modifications to account for. The first modification occurs on July 26,
when the terms of the award are changed to add antidilution provisions. There must be a comparison of the
fair value of the award pre- and postmodification on July 26 in accordance with paragraph 718-20-35-2A to
determine whether the entity should account for the effects of the modifications as described in paragraphs
718-20-35-3 through 35-9. The premodification fair value on July 26 is based on the award without antidilution
provisions taking into account the effect of the contemplated restructuring on its value. The postmodification
fair value is based on an award with antidilution provisions, taking into account the effect of the contemplated
restructuring on its value. Any incremental value transferred would be recognized as additional compensation
cost. Once the equity restructuring occurs, there is a second modification event on September 30 when the
terms of the award are changed in accordance with the antidilution provisions. A second comparison of pre-
and postmodification fair values is then required to determine whether the fair value of the award has changed
as a result of the modification. If there is no change in fair value, vesting conditions, or the classification of
the award, the entity would not account for the effect of the modification on September 30 (see paragraph
718-20-35-2A). Changes to the terms of an award in accordance with its antidilution provisions typically would
not result in additional compensation cost if the antidilution provisions were properly structured. If there is a
change in fair value, vesting conditions, or the classification of the award, the incremental value transferred, if
any, would be recognized as additional compensation cost.
Case C: Original Award Does Not Contain an Antidilution Provision but Is Modified on the Date of Equity
Restructuring
55-106 Assume the same facts as in Case B except the terms of the awards are modified on the date of the
equity restructuring, September 30. In contrast to Case B in which there are two separate modifications, there
is one modification that occurs on September 30 and the fair value is compared pre- and postmodification to
determine whether any incremental value is transferred as a result of the modification. Any incremental value
transferred would be recognized as additional compensation cost.
Example 6-18
Stock Split When a Nondiscretionary Antidilution Provision Is Added

On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options with a grant-date fair-value-
based measure of $6 and an exercise price of $10. The options vest at the end of the third year of service (cliff
vesting) and do not contain an antidilution provision. On July 1, 20X2, A announces a two-for-one stock split and
the addition of a nondiscretionary antidilution provision to each of the options. The fair-value-based measure
of the options immediately before the addition of the antidilution provision is $4, and the fair-value-based
measure immediately afterwards is $7. On December 31, 20X2, the stock split occurs and A (1) modifies the
exercise price of the options and (2) issues additional options to the employee to reflect the effects of the stock
split. The fair-value-based measure of the options before and after the stock split is the same.
299
The addition of the antidilution provision on July 1, 20X2, should be accounted for as a modification. The
$3,000 incremental value, or ($7 – $4) × 1,000 options conveyed to the holder as a result of adding the
nondiscretionary antidilution provision should be recorded as incremental compensation cost over the
remaining 18-month service period. The premodification fair-value-based measure is based on the original
options without a nondiscretionary antidilution provision and takes into account the effect of the contemplated
equity restructuring (i.e., the stock split) on its value. The postmodification fair-value-based measure is based
on the modified options with a nondiscretionary antidilution provision and takes into account the effect of the
contemplated equity restructuring on its value.
On December 31, 20X2, the reduction in the exercise price of the options and the issuance of the additional
options as a result of the stock split would not be subject to modification accounting. Provided that there are
no changes to vesting conditions or the classification of the options, A does not apply modification accounting
since the fair-value-based measure of the options before and after the modification is the same. Changes to
the terms of an award in accordance with its nondiscretionary antidilution provisions often do not result in
incremental compensation cost if the antidilution provisions are structured to retain the same fair-value-based
measure of the award.
Example 6-19
Stock Split When the Original Award Contains Discretionary Antidilution Provisions
Assume the same facts as in the example above, except that the original terms of the options contain a
discretionary antidilution provision. Under the provision, A may — but is not required to — adjust the terms
of the options in response to an equity restructuring (e.g., stock split). Because the antidilution provision is
discretionary, the options are treated as though the provision does not exist. That is, if A were to reduce the
exercise price of the options and issue additional options on December 31, 20X2, it has in substance “added”
a nondiscretionary antidilution provision to the original terms of the options. As a result of the modification
to add a nondiscretionary antidilution provision to the terms of the options, and to reduce the exercise price
of the options and issue additional options, incremental value would be conveyed to the holder (as it was in
the example above). Accordingly, A should record incremental compensation cost for the incremental value
conveyed to the holder on December 31, 20X2, over the remaining 12-month service period.
Alternatively, if A announces on July 1, 20X2, that it will adjust the terms of the options in response to the
stock split, a modification occurs on July 1, 20X2, to effectively add a nondiscretionary antidilution provision
to the options’ terms. The addition of the nondiscretionary antidilution provision results in incremental value
conveyed to the holder. Accordingly, A should record incremental compensation cost of $3,000 (as determined
in the example above) over the remaining 18-month service period.
6.5.1.3 Modification to Add a Nondiscretionary Antidilution Provision That Is Not

in Contemplation of an Equity Restructuring
While adding a nondiscretionary antidilution provision generally increases the value of an award,
a market participant would typically not place significant value on such a provision if an equity
restructuring is not anticipated since it would be difficult to determine the provision’s effect on the
valuation of the award.
Because a modification to add a nondiscretionary antidilution provision that is not made in

contemplation of an equity restructuring would generally result in the same fair-value-based measure
before and after the modification, modification accounting would not be applied as long as there are no
other changes to the award.
300
6.5.2 Spin-Offs
As discussed in Section 6.5.1, a spin-off is considered an equity restructuring. Accordingly, under ASC
718-20-35-6, “[e]xchanges of share options or other equity instruments or changes to their terms in
conjunction with an equity restructuring” are treated as modifications.
In a spin-off, individuals who were originally employees or vendors of an entity (the former parent
or spinnor) that is spinning off a consolidated entity (the former subsidiary or spinnee) may become
employees or vendors of the former subsidiary or remain employees or vendors of the former parent.
Those individuals may exchange their share-based payment awards for awards in the former parent, the
former subsidiary, or both. The former parent’s (spinnor’s) and former subsidiary’s (spinnee’s) accounting
for these share-based payment awards will ultimately be based on whose employees or vendors are
providing the goods or services to earn any remaining portions of the awards after the spin-off.
6.5.2.1 Attribution of Compensation Cost in a Spin-Off

In a spin-off, compensation cost related to share-based payment awards should be recognized by
the entity whose employees or vendors are providing the goods or services to earn any remaining
portions of the award. For those grantees that will continue to provide goods or services to the former
subsidiary, the former parent does not reverse any compensation cost recorded for the awards before
the spin-off date (i.e., the awards are not forfeited). After the spin-off, the former parent no longer
records compensation cost related to the original or modified awards issued to employees or vendors
of the former subsidiary. The remaining unrecognized fair-value-based measure of the original awards
and the incremental compensation cost associated with the modified awards, if any, are recognized by
the former subsidiary over the remaining employee requisite service period or nonemployee’s vesting
period. For those grantees that will continue to provide goods or services to the former parent, the
former parent continues to recognize the remaining unrecognized fair-value-based measure of the
original awards and the incremental compensation cost associated with the modified awards, if any, over
the remaining employee requisite service period or nonemployee’s vesting period.
At its September 1, 2004, meeting, the FASB reached the following conclusion about spin-off
transactions:
In connection with a spinoff transaction and as a result of the related modification, employees of the former
parent may receive unvested equity instruments of the former subsidiary, or employees of the former
subsidiary may retain unvested equity instruments of the former parent. The Board decided that, based on the
current accounting model for spinoff transactions, the former parent and former subsidiary should recognize
compensation cost related to the unvested modified awards for those employees that provide service to
each respective entity. For example, if an employee of the former subsidiary retains unvested equity
instruments of the former parent, the former subsidiary would recognize in its financial statements
the remaining unrecognized compensation cost pertaining to those instruments. In those cases, the
former parent would recognize no compensation cost related to its unvested equity instruments
held by those former employees that subsequent to the spinoff provide services solely to the
former subsidiary. [Emphasis added]
We understand that this guidance was not included in FASB Statement No. 123(R) because the FASB
deleted the example of a spin-off transaction just before issuing the standard. However, the rationale for
the FASB’s conclusion above remains appropriate.
301
6.5.2.2 Classification of Awards in a Spin-Off

Under an exception in FASB Interpretation 44, an entity was not required to change the accounting
method of an award when the award holder’s status changed from employee to nonemployee as
a direct result of a spin-off. If an employee was granted a share-based payment award that was
outstanding as of the date of the spin-off, and that employee was then considered a nonemployee as
a direct result of the spin-off, a change from the intrinsic value method to the fair value method for the
award previously granted was not required under Interpretation 44.
While nullified by FASB Statement 123(R), the guidance in Interpretation 44 remains applicable by
analogy since it contains the only guidance on accounting for share-based payment awards in a spin-off.
For example, ASC 718 does not provide guidance on the classification of awards that are, after a spin-off,
(1) indexed to the spinnor’s equity (i.e., the former parent’s equity) and held by employees or vendors of
the spinnee (i.e., the former subsidiary) or (2) indexed to the spinnee’s equity (i.e., the former subsidiary’s
equity) and held by employees or vendors of the spinnor (i.e., the former parent). Accordingly, in a
manner similar to the exception under which an entity is not required to change its accounting method
when there is a change in the award holder’s status, the spinnee should account for its awards that are
indexed to the spinnor’s equity in the same manner as the spinnor (i.e., equity versus liability); that is,
by using the guidance for share-based payment awards as though the spin-off had not occurred and
provided that no other changes to the award have been made. Likewise, the spinnor should account for
its awards that are indexed to the spinnee’s equity in the same manner as the spinnee.
6.5.2.3 Determining the Market Price Before and After a Spin-Off

To determine whether modification accounting is required and, if so, to account for a modification
in a spin-off, an entity compares the fair-value-based measure of the original share-based payment
award immediately before the spin-off with the fair-value-based measure of the modified share-based
payment award immediately after the spin-off. The fair-value-based measure of the original award
immediately before the spin-off is determined on the basis of the assumptions (e.g., stock price, volatility,
expected dividends, risk-free interest rate) before the spin-off. The fair-value-based measure of the
modified award immediately after the spin-off is determined on the basis of the assumptions that exist
immediately after the spin-off.
Depending on the structure of the share-based payment plan and the spin-off, the market price of the
parent’s shares before and after the spin-off, as well as the market price of the spinnee’s shares after the
transaction, may also be relevant.
The market price of the parent’s shares immediately before the modification should be based on the
closing price on the date of the spin-off, otherwise known as the “record date.” Sometimes the parent’s
shares begin trading on an “ex-dividend” basis before the distribution date, which already excludes
the value of the spinnee’s shares. In these circumstances, and if the spinnee’s shares are trading on a
“when-issued” basis (e.g., after the spinnee’s registration statement is declared effective), to determine
the market price of the parent’s shares immediately before the modification, an entity would add
the distribution-date (i.e., spin-off date) closing price of the spinnee’s shares to the distribution-date
closing price of the parent’s shares, since the parent’s shares incorporate the reduction in value that is
attributable to the spin-off.
The market price of the parent’s shares immediately after the modification is the opening price on the
first trading date after the distribution. However, if the parent’s shares are traded on an ex-dividend
basis and the spinnee’s shares are traded on a when-issued basis, the entity uses the price of the
parent’s shares at the time of the spin-off since the market price will already exclude the closing price of
the spinnee’s shares.
302
The market price of the spinnee’s shares immediately after the modification is the closing price of the
spinnee’s shares on the distribution date as long as the shares are traded on a when-issued basis.
Otherwise, the entity should use the opening price of the spinnee’s shares on the first trading date after
the distribution as the market price of the spinnee’s shares immediately after the modification.
6.5.3 Accounting for Awards Modified in Conjunction With an Equity

Restructuring Held by Individuals No Longer Employed or Providing Goods or
Services
Share-based payment awards that were originally granted to individuals in exchange for goods or
services continue to be accounted for under ASC 718 throughout the awards’ life unless their terms
are modified when a grantee is no longer an employee or a nonemployee has vested in the award and
is no longer providing goods or services. Because changes to an award’s terms in conjunction with
an equity restructuring are treated as a modification, when the individuals are no longer employed or
providing goods or services, the entity would normally be required to account for (1) the modification
in accordance with the guidance in ASC 718 and (2) the award after the modification under other
applicable GAAP. However, if changes to an award’s terms are made solely to reflect an equity
restructuring, ASC 718-10-35-10A does not require the entity (including the spinnor and spinnee in
connection with a spin-off) to account for the award after the modification under other applicable GAAP
if both of the following conditions are met:
manner.
Example 6-20
Former parent P (spinnor) modifies awards held by employees of the former subsidiary (spinnee) as a direct
result of a spin-off. There is no change in the ratio of the awards’ intrinsic value to their exercise price or
addition of an antidilution provision in contemplation of the spin-off, and all holders of the same class of
equity instruments are treated in the same manner. While in accounting for the awards after their terms have
changed P would not consider changes that reflect the spin-off to be a modification that causes the awards
to be accounted for under other applicable GAAP, P still would need to treat the changes to the terms as a
modification in accordance with ASC 718. That is, P would need to consider whether, as a result of the changes
in the awards’ terms, it would be required under ASC 718-20-35-2A and 35-3 to apply modification accounting
and recognize any incremental compensation cost. For example, while the nonemployees may be made whole
if “the ratio of intrinsic value to the exercise price of the award[s] is preserved,” the fair-value-based measure
of the modified awards on the date of the spin-off may be greater than the fair-value-based measure of the
original awards immediately before the spin-off. If so, for unvested awards, the former subsidiary would
recognize incremental compensation cost for the excess of the fair-value-based measure of the modified
awards over the fair-value-based measure of the original awards over the remaining service period.
6.6 Business Combination
ASC 718-20

303
An acquiring entity may issue share-based payment awards (referred to in ASC 805 as “replacement
awards”) to the acquiree’s employees or vendors to replace their existing share-based payment
awards. Exchanges of share-based payment awards in a business combination are considered
modifications under ASC 718-20-35-6. An acquirer often issues replacement awards to ensure that the
acquiree’s employees or vendors are in a similar economic position immediately before and after the
consummation of the business combination. The replacement awards may represent consideration
transferred in the business combination (i.e., they may be related to past goods or services that the
grantees provided to the acquiree before the acquisition date), compensation for future goods or
services (i.e., postcombination goods or services) by the grantees, or both. See Chapter 10 for further
discussion of the accounting treatment of awards that are exchanged in a business combination.
6.7 Short-Term Inducements
Short-Term Inducement
An offer by the entity that would result in modification of an award to which an award holder may subscribe for
a limited period of time.
ASC 718-20
Short-Term Inducements
35-5 Except as described in paragraph 718-20-35-2A, a short-term inducement shall be accounted for as a
modification of the terms of only the awards of grantees who accept the inducement, and other inducements
shall be accounted for as modifications of the terms of all awards subject to them.
The ASC master glossary defines a short-term inducement as an “offer by the entity that would result
in modification of an award to which an award holder may subscribe for a limited period of time.”
Modification accounting applies only to the awards for which holders accept the offer. Entities must use
judgment in determining what constitutes a limited period. If an inducement is not “for a limited period
of time,” it is considered a long-term inducement and is accounted for as a modification of all awards
subject to the inducement, even if the inducement is not accepted by the holder.
The modification date for a short-term inducement is typically the date on which an award holder
accepts the offer (i.e., “opts in”). If award holders opt in on different dates, the entity would have
multiple modification dates. However, if award holders have the ability to withdraw their acceptance
(i.e., “opt out”) before the end of the offer period, the modification date would be the date on which the
withdrawal right expires. By contrast, the modification date of a long-term inducement is the date on
which the inducement is offered, regardless of how many award holders accept the offer or when they
accept it.
See Section 6.10.2 for a discussion of short-term offers to settle an equity award for cash or other
assets.
304
Example 6-21
On January 1, 20X1, Entity A grants 1,000 at-the-money employee stock options to each of its 100 employees.
The options have a grant-date fair-value-based measure of $3 and an exercise price of $10, and they vest at the
end of the third year of service (cliff vesting).
On December 31, 20X1, A offers to all 100 employees the ability to reduce the exercise price of the stock
options to $8 if the employees are willing to extend the vesting period for an additional year. The offer is valid
for the remaining original service period of two years. Because the inducement is not short-term (i.e., it is not
offered for a limited period), A should account for the inducement as a modification of all 100,000 stock options
on December 31, 20X1 (i.e., the modification date), regardless of how many employees accept the offer.
Example 6-22
Assume the same facts as in the example above, except that the employees have only one month to accept the
offer, and those who opt in do not have the ability to opt out once they have accepted the offer. During that
one-month period, 60 employees accept the offer. Entity A would apply modification accounting to only the
60,000 stock options awarded to employees who accepted the offer because it has determined that the offer is
a short-term inducement. In addition, the modification date for each opt-in is the date on which each employee
accepts the offer.
6.8 Modifications That Result in a Change in Classification

A modification can result in a change in an award’s classification from equity to liability or vice versa.
The accounting for the modification will depend on the classification of the award before and after the
modification.
6.8.1 Modification From an Equity Award to a Liability Award

To account for the modification of an award that results in reclassification from equity to liability, an
entity would, on the modification date, recognize a share-based liability for the portion of the award
for which the goods or services have already been provided and multiply that amount by the modified
award’s fair-value-based measure. If the fair-value-based measure of the modified award is less than or
equal to the fair-value-based measure of the original award, the offsetting amount would be recorded
in APIC. If, on the other hand, the fair-value-based measure of the modified award is greater than the
fair-value-based measure of the original award, the excess value would be recognized as additional
compensation cost either immediately (for vested awards) or over the remaining employee requisite
service period or nonemployee’s vesting period (for unvested awards). Because the award has been
reclassified as a liability, it is remeasured at a fair-value-based amount in each reporting period until
settlement. However, total compensation cost cannot be less than the grant-date fair-value-based
measure of the original award if the original award was expected to vest.
The accounting for such a modification differs from that of a settlement of an award. For example, if an
entity cash settles a fully vested equity award rather than modifying its terms to reclassify it as a liability,
the entity does not apply modification accounting. As long as the cash settlement amount is less than
or equal to the award’s then-current fair-value-based measure, no additional compensation cost results
under ASC 718-20-35-7 and the settlement is accounted for as a treasury stock transaction. See Section
6.10.1 for a discussion of a cash settlement that is different from the current fair-value-based measure,
and see Section 6.10.2 for a discussion of how to differentiate between a modification and a settlement.
Example 16 in ASC 718-20-55-123 below describes employee awards; however, the FASB indicates
that the same principles apply to nonemployee awards with similar features as the awards described
in Cases A through E in the determination of total compensation cost to be recognized as a result of a
305
modification. The cost associated with nonemployee awards should be recognized in the same period(s)
and in the same manner as though the grantor had paid cash.
ASC 718-20
Example 16: Modifications That Change an Award’s Classification

Case A: Equity to Liability Modification (Share-Settled Share Options to Cash-Settled Share Options)
55-123 Entity T grants the same share options described in Example 1, Case A (see paragraph 718-20-55-10).
As in Example 1, Case A, Entity T has an accounting policy to estimate the number of forfeitures expected to
occur in accordance with paragraph 718-10-35-3. The number of options for which the requisite service is
expected to be rendered is estimated at the grant date to be 821,406 (900,000 × .973). For simplicity, this Case
assumes that estimated forfeitures equal actual forfeitures. Thus, as shown in the table in paragraph 718-20-
55-130, the fair value of the award at January 1, 20X5, is $12,066,454 (821,406 × $14.69), and the compensation
cost to be recognized during each year of the 3-year vesting period is $4,022,151 ($12,066,454 ÷ 3). The journal
entries for 20X5 are the same as those in paragraph 718-20-55-12.
55-124 On January 1, 20X6, Entity T modifies the share options granted to allow the employee the choice of
share settlement or net cash settlement; the options no longer qualify as equity because the holder can require
Entity T to settle the options by delivering cash. Because the modification affects no other terms or conditions
of the options, the fair value (assumed to be $7 per share option) of the modified award equals the fair value
of the original award immediately before its terms are modified on the date of modification; the modification
also does not change the number of share options for which the requisite service is expected to be rendered.
On the modification date, Entity T recognizes a liability equal to the portion of the award attributed to past
service multiplied by the modified award’s fair value. To the extent that the liability equals or is less than the
amount recognized in equity for the original award, the offsetting debit is a charge to equity. To the extent
that the liability exceeds the amount recognized in equity for the original award, the excess is recognized as
compensation cost. In this Case, at the modification date, one-third of the award is attributed to past service
(one year of service rendered/three-year requisite service period). The modified award’s fair value is $5,749,842
(821,406 × $7), and the liability to be recognized at the modification date is $1,916,614 ($5,749,842 ÷ 3). The
related journal entry follows.

Share-based compensation liability $1,916,614
To recognize the share-based compensation liability.
55-125 No entry would be made to the deferred tax accounts at the modification date. The amount of
remaining additional paid-in capital attributable to compensation cost recognized in 20X5 is $2,105,537
($4,022,151 – $1,916,614).
55-126 Paragraph 718-20-35-3(b) specifies that total recognized compensation cost for an equity award
shall at least equal the fair value of the award at the grant date unless at the date of the modification the
service or performance conditions of the original award are not expected to be satisfied. In accordance with
that principle, Entity T would ultimately recognize cumulative compensation cost equal to the greater of the
following:
a. The grant-date fair value of the original equity award
b. The fair value of the modified liability award when it is settled.
55-127 To the extent that the recognized fair value of the modified liability award is less than the recognized
compensation cost associated with the grant-date fair value of the original equity award, changes in that
liability award’s fair value through its settlement do not affect the amount of compensation cost recognized.
To the extent that the fair value of the modified liability award exceeds the recognized compensation cost
associated with the grant-date fair value of the original equity award, changes in the liability award’s fair value
are recognized as compensation cost.
306
55-128 At December 31, 20X6, the fair value of the modified award is assumed to be $25 per share option;
hence, the modified award’s fair value is $20,535,150 (821,406 × $25), and the corresponding liability at that
date is $13,690,100 ($20,535,150 × 2/3) because two-thirds of the requisite service period has been rendered.
The increase in the fair value of the liability award is $11,773,486 ($13,690,100 – $1,916,614). Before any
adjustments for 20X6, the amount of remaining additional paid-in capital attributable to compensation cost
recognized in 20X5 is $2,105,537 ($4,022,151 – $1,916,614). The cumulative compensation cost at December
31, 20X6, associated with the grant-date fair value of the original equity award is $8,044,302 ($4,022,151 × 2).
Entity T would record the following journal entries for 20X6.

To increase the share-based compensation liability to $13,690,100
and recognize compensation cost of $9,667,949 ($13,690,100 –
$4,022,151).

To recognize the deferred tax asset for additional compensation
cost ($9,667,949 × .35 = $3,383,782).
55-129 At December 31, 20X7, the fair value is assumed to be $10 per share option; hence, the modified
award’s fair value is $8,214,060 (821,406 × $10), and the corresponding liability for the fully vested award
at that date is $8,214,060. The decrease in the fair value of the liability award is $5,476,040 ($8,214,060 –
$13,690,100). The cumulative compensation cost as of December 31, 20X7, associated with the grant-date fair
value of the original equity award is $12,066,454 (see paragraph 718-20-55-123). Entity T would record the
following journal entries for 20X7.

To recognize a share-based compensation liability of $8,214,060, a
reduction of compensation cost of $1,623,646 ($13,690,100 –
$12,066,454), and additional paid-in capital of $3,852,394
($12,066,454 – $8,214,060).

To reduce the deferred tax asset for the reduction in compensation
cost ($1,623,646 × .35 = $568,276).
307
55-130 The modified liability award is as follows.
Modified Liability Award — Cliff Vesting
Cumulative
Year Total Value of Award Pretax Cost for Year Pretax Cost
20X5 $12,066,454 (821,406 × $14.69) $4,022,151 ($12,066,454 ÷ 3) $ 4,022,151
20X6 $20,535,150 (821,406 × $25.00) $9,667,949 [($20,535,150 × 2/3) – $4,022,151] $ 13,690,100
20X7 $12,066,454 (821,406 × $14.69) $(1,623,646) ($12,066,454 – $13,690,100) $ 12,066,454
55-131 For simplicity, this Case assumes that all share option holders elected to be paid in cash on the same
day, that the liability award’s fair value is $10 per option, and that Entity T has already recognized its income tax
expense for the year without regard to the effects of the settlement of the award. In other words, current tax
expense and current taxes payable were recognized based on income and deductions before consideration of
additional deductions from settlement of the award.
55-132 The $8,214,060 in cash paid to the employees on the date of settlement is deductible for tax purposes.
In the period of settlement, tax return deductions that are less than compensation cost recognized result in a
charge to income tax expense. The tax benefit is $2,874,921 ($8,214,060 × .35). Because tax return deductions
are less than compensation cost recognized, the entity must write off the deferred tax assets recognized in
excess of the tax benefit from the exercise of employee stock options to income tax expense in the income
statement. The journal entries to reflect settlement of the share options are as follows.

Cash ($10 × 821,406) $8,214,060
To recognize the cash paid to settle share options.

To write off deferred tax asset related to compensation cost
($12,066,454 × .35 = $4,223,259).

To adjust current tax expense and current taxes payable for the tax
benefit from deductible compensation cost upon settlement of
share options.
55-133 If instead of requesting cash, employees had held their share options and those options had expired
worthless, the share-based compensation liability account would have been eliminated over time with a
corresponding increase to additional paid-in capital. Previously recognized compensation cost would not be
reversed. Similar to the adjustment for the actual tax deduction described in paragraph 718-20-55-132, all of
the deferred tax asset of $4,223,259 would be charged to income tax expense when the share options expire.
308
Case E: Equity to Liability Modification (Share Options to Fixed Cash Payment)

55-144 Entity T grants the same share options described in Example 1, Case A (see paragraph 718-20-55-
10) and records similar journal entries for 20X5 (see paragraphs 718-20-55-12 through 55-16). By January 1,
20X6, Entity T’s share price has fallen, and the fair value per share option is assumed to be $2 at that date.
Entity T provides its employees with an election to convert each share option into an award of a fixed amount
of cash equal to the fair value of each share option on the election date ($2) accrued over the remaining
requisite service period, payable upon vesting. The election does not affect vesting; that is, employees must
satisfy the original service condition to vest in the award for a fixed amount of cash. Entity T considers the
guidance in paragraph 718-20-35-2A. Because the change in the terms or conditions of the award changes
the classification of the award from equity to liability, Entity T applies modification accounting. This transaction
is considered a modification instead of a settlement because Entity T continues to have an obligation to
its employees that is conditional upon the receipt of future employee services. There is no incremental
compensation cost because the fair value of the modified award is the same as that of the original award. At
the date of the modification, a liability of $547,604 [(821,406 × $2) × (1 year of requisite service rendered ÷
3-year requisite service period)], which is equal to the portion of the award attributed to past service multiplied
by the modified award’s fair value, is recognized by reclassifying that amount from additional paid-in capital.
The total liability of $1,642,812 (821,406 × $2) should be fully accrued by the end of the requisite service period.
Because the possible tax deduction of the modified award is capped at $1,642,812, Entity T also must adjust its
deferred tax asset at the date of the modification to the amount that corresponds to the recognized liability of
$547,604. That amount is $191,661 ($547,604 × .35), and the write-off of the deferred tax asset is $1,216,092
($1,407,753 – $191,661). That write-off would be recognized as income tax expense in the income statement.
Compensation cost of $4,022,151 would be recognized in each of 20X6 and 20X7 for a cumulative total of
$12,066,454 (as calculated in Case A); of this, $547,604 would be recognized as an increase to the liability
balance, with the remaining $3,474,547 recognized as an increase in additional paid-in capital. A deferred tax
benefit would be recognized in the income statement, and a corresponding increase to the deferred tax asset
would be recognized for the tax effect of the increased liability of $191,661 ($547,604 × .35). The compensation
cost recognized in additional paid-in capital in this situation has no associated income tax effect (additional
deferred tax assets are recognized based only on subsequent increases in the amount of the liability).
Example 6-23
On January 1, 20X1, Entity A grants 1,000 at-the-money share-settled SARs, each with a grant-date fair-value-
based measure of $3. The SARs vest at the end of the fourth year of service (cliff vesting). On December 31,
20X2, A modifies the awards from share-settled SARs to cash-settled SARs. The fair-value-based measure of the
SARs on December 31, 20X2, and December 31, 20X3, is $4 and $5, respectively.
Because the modification only affects the SARs’ settlement feature (i.e., cash settlement vs. share settlement),
the fair-value-based measure of the modified SARs presumably equals the fair-value-based measure of the
original SARs immediately before modification. Accordingly, there is no incremental value conveyed to the
holder of the SARs.
However, because the modification-date fair-value-based measure is greater than the grant-date fair-value-
based measure, A (1) reclassifies the amount currently residing in APIC, $1,500 (1,000 SARs × $3 grant-date
fair-value-based measure × 50% for two of four years of services rendered), as a share-based liability and
(2) records the excess $500 — ($4 modification-date fair-value-based measure – $3 grant-date fair-value-based
measure) × 1,000 SARs × 50% for two of four years of services rendered — as additional compensation cost to
record the new liability award at its fair-value-based measure, with a corresponding adjustment to share-based
liability in the period of modification. See the journal entries below.

APIC 750
To record compensation cost for each of the years ended December
31, 20X1 and 20X2.
309
Journal Entry: Date of Modification
APIC 1,500
Share-based liability 2,000
To record the award as a liability on the date of modification.
Now that the SARs are classified as a liability, A must remeasure them at their fair-value-based amount in each
reporting period until settlement in accordance with ASC 718-30-35-2. (Chapter 7 discusses the differences
between the accounting treatment of equity and liability awards.) See the journal entry below.

To remeasure the liability award at the fair-value-based amount at
the end of the next reporting period (December 31, 20X3) [(1,000
SARs × $5 fair-value-based measure × 75% for three of four
years of services rendered) – $2,000 compensation cost previously
recognized].
Example 6-24
Assume all the same facts as in the example above, except that the fair-value-based measure of the SARs on
the date of modification (December 31, 20X2) and December 31, 20X3, is $2.50 and $2, respectively. Entity A
reclassifies the portion of the SARs’ modification-date fair-value-based measure of $1,250 (1,000 SARs × $2.50
fair-value-based measure × 50% for two of four years of services rendered) currently residing in APIC as a
share-based liability. See the journal entries below.

APIC 750
31, 20X1 and 20X2.
APIC 1,250
To record the award as a liability on the date of modification.
Now that the SARs are classified as a liability, in accordance with ASC 718-30-35-2, A must remeasure them
at their fair-value-based amount in each reporting period until settlement. If the value of the liability award at
settlement is less than its grant-date fair-value-based measure, then total compensation cost will equal the
grant-date fair-value-based measure, and a portion of that value will remain in equity. On the other hand,
if at settlement the value of the liability award is greater than its grant-date fair-value-based measure, total
compensation cost will equal the liability award’s value at settlement. This conclusion is consistent with the
requirement in ASC 718 that compensation cost for an equity award (i.e., the original award’s treatment before
modification) should generally be recorded at least at its grant-date fair-value-based measure if the original
award was expected to vest. See the journal entries below.
310

APIC 750
To record compensation cost based on the grant-date fair-value-
based measure ($3) and the continued employee service (one of
four years).
APIC 250
Share-based liability 250
To remeasure the liability award at the fair-value-based amount at
the end of the next reporting period (December 31, 20X3) [(1,000
SARs × $2 fair-value-based measure × 75% for three of four years
of services rendered) – $1,250 share-based compensation liability
6.8.2 Modification From a Liability Award to an Equity Award

The treatment of a modification that changes an award’s classification from liability to equity is different
from the treatment of other modifications, for which total recognized compensation cost attributable
to an award that has been modified is, at least, the grant-date fair-value-based measure of the original
award unless the original award was not expected to vest. For liability to equity modifications, the
aggregate amount of compensation cost recognized is generally the fair-value-based measure of the
award on the modification date. To account for the modification, an entity would, on the modification
date, record the amounts previously recorded as a share-based compensation liability as a component
of equity in the form of a credit to APIC. Because the award is no longer classified as a liability, it no
longer has to be remeasured at a fair-value-based amount in each reporting period until settlement.
ASC 718-30
Example 1: Cash-Settled Stock Appreciation Right

55-1 This Example illustrates the guidance in paragraphs 718-30-35-2 through 35-4 and 718-740-25-2 through
25-4.
concepts about valuation and forfeiture estimation and remeasurement of awards, exercise, and expiration in
paragraphs 718-30-55-2 through 55-11 are equally applicable to nonemployee awards with the same features
as the awards in this Example (that is, awards with a specified period of time for vesting classified as liabilities).
awards.
transactions.
311
55-2 Entity T, a public entity, grants share appreciation rights with the same terms and conditions as those
described in Example 1 (see paragraph 718-20-55-4). As in Example 1, Case A, Entity T makes an accounting
policy election in accordance with paragraph 718-10-35-3 to estimate the number of forfeitures expected
to occur and includes that estimate in its initial accrual of compensation costs. Each stock appreciation right
entitles the holder to receive an amount in cash equal to the increase in value of 1 share of Entity T stock over
$30. Entity T determines the grant-date fair value of each stock appreciation right in the same manner as a
share option and uses the same assumptions and option-pricing model used to estimate the fair value of
the share options in that Example; consequently, the grant-date fair value of each stock appreciation right is
$14.69 (see paragraphs 718-20-55-7 through 55-9). The awards cliff-vest at the end of three years of service
(an explicit and requisite service period of three years). The number of stock appreciation rights for which the
requisite service is expected to be rendered is estimated at the grant date to be 821,406 (900,000 × .973). Thus,
the fair value of the award as of January 1, 20X5, is $12,066,454 (821,406 × $14.69). For simplicity, this Example
assumes that estimated forfeitures equal actual forfeitures.
ASC 718-20
Example 16: Modifications That Change an Award’s Classification

Case C: Liability to Equity Modification (Cash-Settled to Share-Settled Stock Appreciation Rights)
55-135 This Case is based on the facts given in Example 1 (see paragraph 718-30-55-1). Entity T grants cash-
settled stock appreciation rights to its employees. The fair value of the award on January 1, 20X5, is $12,066,454
(821,406 × $14.69) (see paragraph 718-30-55-2).
55-136 On December 31, 20X5, the assumed fair value is $10 per stock appreciation right; hence, the fair value
of the award at that date is $8,214,060 (821,406 × $10). The share-based compensation liability at December
31, 20X5, is $2,738,020 ($8,214,060 ÷ 3), which reflects the portion of the award related to the requisite service
provided in 20X5 (1 year of the 3-year requisite service period). For convenience, this Case assumes that journal
entries to account for the award are performed at year-end. The journal entries for 20X5 are as follows.


related to compensation cost ($2,738,020 × .35 = $958,307).
312
55-137 On January 1, 20X6, Entity T modifies the stock appreciation rights by replacing the cash-settlement
feature with a net share settlement feature, which converts the award from a liability award to an equity award
because Entity T no longer has an obligation to transfer cash to settle the arrangement. Entity T would compare
the fair value of the instrument immediately before the modification to the fair value of the modified award and
recognize any incremental compensation cost. Because the modification affects no other terms or conditions,
the fair value, assumed to be $10 per stock appreciation right, is unchanged by the modification and, therefore,
no incremental compensation cost is recognized. The modified award’s total fair value is $8,214,060. The
modified award would be accounted for as an equity award from the date of modification with a fair value
of $10 per share. Therefore, at the modification date, the entity would reclassify the liability of $2,738,020
recognized on December 31, 20X5, as additional paid-in capital. The related journal entry is as follows.

To reclassify the award as equity.
55-138 Entity T will account for the modified awards as equity going forward following the pattern given in
Example 1, Case A (see paragraph 718-20-55-1), recognizing $2,738,020 of compensation cost in each of 20X6
and 20X7, for a cumulative total of $8,214,060.
Example 6-25
On January 1, 20X1, Entity A grants 1,000 at-the-money cash-settled SARs, each with a grant-date fair-value-
based measure of $3. The SARs vest at the end of the fourth year of service (cliff vesting). On December 31,
20X1, the SARs’ fair-value-based measure is still $3. On December 31, 20X2, A modifies the awards, changing
them from cash-settled SARs to share-settled restricted stock awards. The fair-value-based measure of the
restricted stock awards on December 31, 20X2, is $7, and the fair-value-based measure of the original SARs
immediately before modification is $5.
The modification to replace the original SARs awards with restricted stock awards and to change the settlement
feature of the awards (i.e., share settlement versus cash settlement) increases the fair-value-based measure of
the modified restricted stock awards relative to the fair-value-based measure of the original SARs immediately
before modification. Accordingly, since there is incremental value conveyed to the holder of the restricted stock
awards in connection with the modification from liability to equity, A will record incremental compensation cost
of $2,000, or ($7 – $5) × 1,000 restricted stock awards, over the remaining two years of service required.
On December 31, 20X2, the modified restricted stock awards are accounted for as an equity award from
the date of modification, with compensation cost fixed at $7 (which is the fair-value-based measure on the
modification date). As a result, A reclassifies as APIC the amount previously recorded as a share-based liability
($2,500 = 1,000 SARs × $5 modification-date fair-value-based measure × 50% for two of four years of services
rendered). In addition, A records the remaining $4,500 of compensation cost (1,000 restricted stock awards ×
$7 modification-date fair-value-based measure – $2,500 previously recognized compensation cost) over the
remaining service period (two years). See the journal entries below.

Share-based liability 750
To record compensation cost for the year ended December 31, 20X1
(1,000 SARs × $3 fair-value-based measure × 25% for one of four
years of services rendered).
313

20X2 [(1,000 SARs × $5 fair-value-based measure × 50% for two
of four years of services rendered) – $750 previously recognized
compensation cost].

APIC 2,500
To record the award as an equity award on the date of modification.

APIC 2,250
31, 20X3 and 20X4 {[(1,000 restricted stock awards × $7 fair-value-
based measure) – $2,500 previously recognized compensation
cost] × 50% for each one of two remaining years of service}.
When a reduction in an award’s fair-value-based measure occurs in conjunction with a change in

its classification from liability to equity, an entity should record the reduction in the fair-value-based
measure in equity (as APIC), not in the income statement. Grantees ordinarily would not exchange one
award for another that is less valuable. Therefore, their acceptance of the new award is analogous
to debt forgiveness by a related party and should be treated as a contribution of capital (see ASC
470-50-40-2).
This situation is also analogous to the example described in paragraph 5 of FASB Interpretation 28, in
which employees are granted a combination award (i.e., SARs that are exercisable for the same period
as companion stock options, and the exercise of either cancels the other). If circumstances change and
the employee will exercise the stock option rather than the SAR, accrued compensation related to the
appreciation right is not adjusted. Although Interpretation 28 has been nullified by FASB Statement
123(R), the guidance in paragraph 5 remains applicable by analogy.
314
Example 6-26
On January 1, 20X1, Entity A grants 100 cash-settled performance units to each of its 100 employees. The units
vest at the end of the third year of service (cliff vesting). On January 1, 20X2, A modifies the units (after obtaining
approval from each of the unit holders) to require settlement in shares and further restricts the employees
from selling the shares for one year after they become vested. The fair-value-based measure of the units
immediately before modification is $12, and the fair-value-based measure of the modified award is $11. The
decrease in value is attributable to the addition of the restriction on the ability to sell the vested shares.
On December 31, 20X1, A records the 20X1 compensation cost and a corresponding share-based liability on
the basis of the current fair-value-based measure of the units ($12), the number of units to be issued (10,000),
and the percent of services rendered (33 percent for one of three years of services rendered). See the journal
entry below.

On January 1, 20X2, A accounts for the modification by first reclassifying the accumulated value of the equity
award (on the basis of the new fair-value-based measure) as APIC (10,000 units × $11 fair-value-based measure
× 33% for one of three years of services rendered = $36,667). Next, A reclassifies the remaining share-based
liability (representing the employees’ capital contributions) as equity ($40,000 – $36,667 = $3,333). See the
journal entry below.

APIC 36,667
APIC — capital contribution 3,333
Using the new fair-value-based measure of the award, A records the entry below to recognize the
compensation cost of $36,667 (10,000 units × $11 fair-value-based measure × 33% for one of three years of
services rendered) for both 20X2 and 20X3.

APIC 36,667
6.9 Modifications Under ASR 268

SEC ASR 268 and ASC 480-10-S99-3A require (with limited exceptions) temporary-equity classification
for share-based payment awards with redemption features not solely within the control of the entity (as
long as the awards would not otherwise be classified as liabilities). See Section 5.10 for a discussion of
classification of awards with redemption features not solely within the control of the entity.
The modification guidance in ASC 718-20 also applies to awards that are accounted for in accordance
with ASR 268 and ASC 480-10-S99-3A. In other words, SEC registrants are required to record the
incremental fair-value-based measure, if any, of the modified award as compensation cost on the
date of modification (for vested awards) or over the remaining service period (for unvested awards). In
addition, SEC registrants are required to reclassify the redemption amount to temporary equity on the
modification date.
315
Example 6-27
Accounting for the Modification of an Award With a Contingent Cash-Settlement Feature

On January 1, 20X1, Entity A, an SEC registrant, granted 1,000 at-the-money employee stock options, each with a
grant-date fair-value-based measure of $12 and an exercise price of $25. The options vest at the end of the fifth
year of service (cliff vesting) and contain a redemption feature permitting the employee to require A to net cash
settle the options upon a change in control (the occurrence of which is not probable as of the grant date).
Since the options were granted at-the-money and are not fully vested (i.e., the intrinsic value on the grant
date is zero), no amount is initially reclassified as temporary equity. However, because the options contain a
redemption feature that is not solely within the control of A, A is required to remeasure the options to their
redemption value (i.e., their intrinsic value) in temporary equity once it is considered probable that the change-
in-control event (i.e., the contingent redemption feature) will occur (generally when the change-in-control event
occurs). Accordingly, for the year ended December 31, 20X1, A (1) recognizes compensation cost on the basis of
the grant-date fair-value-based measure of the options and (2) reclassifies no amount as temporary equity. See
the journal entry below.

APIC 2,400
(1,000 options × $12 grant-date fair-value-based measure × 20%
for one of five years of services rendered).
On January 1, 20X2, A modifies the options to reduce the requisite service period from five years to four years.
Because the modification affects only the options’ service period, which is now shorter, the fair-value-based
measure of the modified options would most likely be equal to or less than the fair-value-based measure of the
original options immediately before modification. Accordingly, there is no incremental value conveyed to the
holder of the award; therefore, no incremental compensation cost has to be recorded in connection with this
modification. Entity A will recognize the remaining unrecognized compensation cost (1,000 options × $12 grant-
date fair-value-based measure – $2,400 amount previously recognized = $9,600) over the remainder of the
modified requisite service period (three years).
However, on the modification date, the market price of A’s shares is $27, while the exercise price of the options
remained at $25. Because the modification of an award is viewed as the exchange of a new award for an old
award, A must again consider the application of the measurement guidance in ASR 268 and ASC 480-10-S99-3A
as of the modification date. Therefore, in accordance with ASC 480-10-S99-3A, A will reclassify the redemption
amount (i.e., the intrinsic value of the options on the modification date) as temporary equity. Accordingly, in
20X2, A (1) recognizes compensation cost on the basis of the options’ grant-date fair-value-based measure and
(2) reclassifies as temporary equity an amount based on the options’ intrinsic value ($2) and the portion of the
requisite service rendered. See the journal entries below.
316
APIC 500
Temporary equity 500
To reclassify the redemption value (i.e., the intrinsic value of the
options on the modification date) from APIC to temporary equity
in accordance with ASC 480-10-S99-3A [1,000 options × ($27
market price of A’s shares – $25 exercise price) × 25% for one
of four years of services rendered]. The remaining $1,500 [1,000
options × ($27 market price – $25 exercise price) – $500
reclassified on January 1, 20X2] would be reclassified as temporary
equity over the three years of remaining service. Entity A would not
be required to remeasure the amount recorded in temporary
equity until the change in control becomes probable, at which
time A would remeasure the amount on the basis of its current
redemption value.

APIC 3,200
[(1,000 options × $12 grant-date fair-value-based measure –
$2,400 amount previously recognized) × 33% for one of three years
of service remaining].
APIC 500
options on the modification date) from APIC to temporary equity
in accordance with ASC 480-10-S99-3A [(1,000 options × ($27
modification-date market price of A’s shares – $25 exercise price) ×
50% for two of four years of services rendered) – $500 previously
reclassified]. Entity A would not be required to remeasure the
amount recorded in temporary equity until the change in control
becomes probable, at which time A would remeasure the amount
on the basis of its current redemption value.
Example 6-28
Accounting for the Modification of an Award That Is Puttable by the Employee

On January 1, 20X1, Entity A, an SEC registrant, granted 1,000 at-the-money employee stock options, each with
a grant-date fair-value-based measure of $6 and an exercise price of $15. The options vest at the end of the
fifth year of service (cliff vesting). In addition, the shares underlying the options contain a redemption feature
allowing the employee to require A to repurchase the shares at the then-current fair value six months and one
day after exercise of the options.
317
Since the options were granted at-the-money and are not fully vested (i.e., the intrinsic value on the grant
date is zero), no amount is initially reclassified to temporary equity. However, because the options contain
a redemption feature, A is required to remeasure the options to their redemption value (i.e., their intrinsic
value) in temporary equity in each reporting period until settlement. The amount recorded in temporary
equity is based on the options’ redemption amount and the portion of the requisite service rendered as of
each reporting period. On December 31, 20X1, the market price of A’s shares is $18. Accordingly, for the year
ended December 31, 20X1, A (1) recognizes compensation cost on the basis of the grant-date fair-value-based
measure of the options and (2) reclassifies as temporary equity an amount based on the options’ intrinsic value
($3) and the portion of the requisite service rendered. See the journal entries below.

APIC 1,200
(1,000 options × $6 grant-date fair-value-based measure × 20% for
one of five years of services rendered).
APIC 600
options at the end of the reporting period) from APIC to temporary
equity in accordance with ASC 480-10-S99-3A [1,000 options × ($18
market price of A’s shares – $15 exercise price) × 20% for one of
five years of services rendered].
On January 1, 20X2, A modifies the options to reduce the requisite service period from five years to four years.
Because the modification only affects the service period of the options, and the service period is shorter, the
fair-value-based measure of the modified options would most likely be equal to or less than the fair-value-
based measure of the original options immediately before modification. Accordingly, there is no incremental
value conveyed to the holder of the award; therefore, no incremental compensation cost has to be recorded in
connection with this modification. Entity A will recognize the remaining unrecognized compensation cost (1,000
options × $6 grant-date fair-value-based measure – $1,200 amount previously recognized = $4,800) over the
remainder of the modified requisite service period (three years).
318
On the modification date, the market price of A’s shares is $17, while the exercise price of the options remained
at $15. The market price of A’s shares increases to $19 as of December 31, 20X2. In accordance with ASR 268
and ASC 480-10-S99-3A, A will reclassify the redemption amount (i.e., the intrinsic value of the options on the
modification date) as temporary equity. Accordingly, for the year ended December 31, 20X2, A (1) recognizes
compensation cost on the basis of the grant-date fair-value-based measure of the options and (2) reclassifies as
temporary equity an amount based on the options’ intrinsic value ($4) and the portion of the requisite service
rendered. See the journal entries below.

APIC 1,600
[(1,000 options × $6 grant-date fair-value-based measure – $1,200
amount previously recognized) × 33% for one of three years of
services remaining].
APIC 1,400
options on December 31, 20X2) from APIC to temporary equity in
accordance with ASR 268 and ASC 480-10-S99-3A {[1,000 options ×
($19 market price of A’s shares – $15 exercise price) × 50% for
two of four years of services rendered] – $600 amount previously
reclassified}.
6.10 Repurchases and Settlements

ASC 718-20
Repurchase or Cancellation
35-7 The amount of cash or other assets transferred (or liabilities incurred) to repurchase an equity award
shall be charged to equity, to the extent that the amount paid does not exceed the fair value of the equity
instruments repurchased at the repurchase date. Any excess of the repurchase price over the fair value of
the instruments repurchased shall be recognized as additional compensation cost. An entity that repurchases
an award for which the promised goods have not been delivered or the service has not been rendered has,
in effect, modified the employee’s requisite service period or nonemployee’s vesting period to the period
for which goods have already been delivered or service already has been rendered, and thus the amount of
compensation cost measured at the grant date but not yet recognized shall be recognized at the repurchase
date.
A settlement is a payment (usually in the form of shares or cash) made to fulfill a share-based payment
award. Stock options are typically settled in shares, while many phantom stock unit plans are settled in
cash. In addition, certain share-based payment plans may give the entity the option to repurchase the
underlying shares in cash, may give the grantee the option to sell them for cash, or do both.
319
An entity must carefully consider whether any cash-settlement features affect an award’s classification.
Even if an award’s terms do not permit cash settlement, an entity’s past practice of settling or
intending to settle awards in cash before the risks and rewards of share ownership are borne by
grantees (generally six months from the date options are exercised or shares are vested) may indicate
that awards are in-substance liabilities. See Chapter 5 for a detailed discussion of determining the
classification of an award.
Because cash settlement is often required under the terms of liability-classified awards, use of the term
“settlement” in this section generally refers to the payment made to satisfy an award that is equity-classified
and includes the repurchase of equity instruments. While the next section discusses the settlement
of share-based payment awards in cash, the guidance also applies to settlements in other assets or
liabilities.
6.10.1 Cash Settlements
The amount of cash paid to settle an equity-classified award is charged directly to equity as long as
that amount is equal to or less than the fair-value-based measure of the award on the settlement date.
To the extent that the settlement consideration exceeds the fair-value-based measure of the equity-
classified award on the settlement date, that difference is recognized as additional compensation cost.
If an entity settles an unvested award (i.e., an award for which the goods or services have not been
provided), the entity has effectively modified the award to accelerate the vesting conditions associated
with it. Accordingly, any remaining unrecognized compensation cost is generally recognized immediately
on the settlement date.
The example below is based on the same facts as in Example 1 in ASC 718-20-55-4 through 55-9 (see
Section 6.1).
ASC 718-20
Example 12: Modifications and Settlements

Case D: Cash Settlement of Nonvested Share Options
55-102 Rather than modify the share option terms, Entity T offers on January 1, 20X6, to settle the original
January 1, 20X5, grant of share options for cash. Because the share price decreased from $30 at the grant date
to $20 at the date of settlement, the fair value of each share option is $5.36, the same as in Case C. If Entity
T pays $5.36 per share option, it would recognize that cash settlement as the repurchase of an outstanding
equity instrument and no incremental compensation cost would be recognized. However, the cash settlement
of the share options effectively vests them. Therefore, the remaining unrecognized compensation cost of $9.79
per share option would be recognized at the date of settlement.
Example 6-29
fair-value-based measure of $9. The options vest at the end of the fourth year of service (cliff vesting). On
December 31, 20X2, the market price of A’s stock has declined so dramatically that A wishes to settle the
options because they provide little future incentive value to its employees. In this case, the employees may be
willing to relinquish the options for an amount less than their then-current fair-value-based measure because
payment would be immediate, settlement would not require future service, and the options may not become
in-the-money during the expected term. The fair-value-based measure of the options on the settlement date is
$3.50, and A settles the options for $2 in cash.
320
Before settlement, A recorded compensation cost of $4,500 on the basis of the number of options expected
to vest (1,000 options, assuming no forfeitures), the grant-date fair-value-based measure of the options ($9),
and the amount of services rendered (50 percent for two of four years of services rendered). On the settlement
date, A would record the amount of cash paid ($2,000 = 1,000 options × $2 cash paid per option), with a
corresponding charge to equity. Simultaneously, A would record the remaining unrecognized compensation
cost ($4,500) because the options have fully vested as a result of the settlement. See the journal entries below
(recorded on the settlement date).

APIC 4,500
To record the remaining unrecognized compensation cost on the
date of settlement.
APIC 2,000
Cash 2,000
To record the amount of cash paid to settle the options with a
corresponding charge to equity.
An entity may make a cash payment to a grantee and concurrently cancel that grantee’s awards. While
the transaction would typically be accounted for as a settlement, the determination of whether such
a payment is a modification, settlement, or other action is based on the facts and circumstances of
each situation. For example, an entity may enter into a separation agreement with an employee to
terminate employment or terminate an arrangement with a nonemployee in which the entity (1) will
make a termination payment in cash and (2) separately cancel all of the grantee’s outstanding share-
based payment awards. The entity should account for the separation agreement and cancellation of the
awards as a single transaction. That is, the entity should view the termination arrangement and related
termination payment as the repurchase of all outstanding awards for cash. Accordingly, as long as the
settlement consideration does not exceed the fair-value-based measure of the equity-classified awards
as of the settlement date, the entity records no additional compensation cost and charges the amount
of cash paid to settle the awards directly to equity. If the settlement consideration exceeds the fair-
value-based measure of the equity-classified awards as of the settlement date, the entity recognizes the
amount in excess of the fair-value-based measure as additional compensation cost.
In determining the accounting for the awards that are settled, the entity should consider the vested and
unvested awards as follows:
• Vested awards — Since the termination payment for the vested awards is a settlement, the entity
should recognize as a charge to equity the amount paid to repurchase the vested awards that is
less than or equal to the fair-value-based measure of the vested awards on the repurchase date.
• Unvested awards — Since the grantee will not render the services or deliver the goods to earn
the awards, the unvested awards are not expected to vest as of the separation date. Therefore,
the entity should reverse any previously recognized compensation cost related to the unvested
awards. The termination payment is an improbable-to-probable modification of the unvested
awards. (See Sections 6.3 and 6.3.3 for a discussion of improbable-to-probable modifications.)
That is, as a result of the termination arrangement, the grantee would not have vested in these
awards upon termination of employment or the arrangement with a nonemployee (improbable).
The termination payment effectively accelerated the awards’ vesting (i.e., made it probable that
321
the awards would vest upon cash settlement). Accordingly, the total fair-value-based measure
of the unvested awards is zero immediately before settlement on the separation date (0
awards expected to vest × fair-value-based measure of the unvested awards as of the date of
the separation agreement). To determine the incremental compensation cost resulting from
the settlement, the entity would subtract this value (zero) from the cash paid for the unvested
awards (i.e., any cash paid in excess of the fair-value-based measure of the vested awards).
Therefore, the entity would recognize the amount of cash paid for the unvested awards
as compensation cost on the date of the termination arrangement. No amount should be
recognized as the repurchase of an equity-classified award.
The decision tree below addresses cash settlement as part of an employee separation.
Vested Awards Is the cash

Account for transaction as a payment to settle
settlement. (1) vested Unvested Awards
or (2) unvested
(Section 6.10.1) awards?
Reverse previously recognized

compensation cost and account
Is the cash for the settlement as a Type III
payment less improbable-to-probable modification
than or equal to the No Recognize the amount in excess of that accelerates vesting.
fair-value-based measure the fair-value-based measure as
of the vested awards additional compensation cost. (Section 6.3.3)
on the repurchase
date?
Yes
Recognize as a charge to equity

the amount paid to repurchase
the vested awards.
322
Example 6-30
On January 1, 20X3, Entity A enters into a separation agreement with one of its executives, who also terminates
employment on that date:
• In connection with the separation agreement, A agrees to pay $1 million in cash to the executive upon
termination of employment.
• The executive concurrently agrees to cancel all outstanding employee options to purchase A’s common
stock (both vested and unvested).
• The executive has 10,000 vested employee stock options, each with a grant-date fair-value-based
measure of $30 and a fair-value-based measure of $40, on January 1, 20X3.
• The executive has 10,000 unvested employee stock options, each with a grant-date fair-value-based
measure of $35 and a fair-value-based measure of $42, on January 1, 20X3. The options were granted on
January 1, 20X1, and vest at the end of the fourth year of service (cliff vesting).
In determining the fair-value-based measure of the outstanding options that are settled, A should consider the
vested and unvested options as follows:
Vested Options
The termination payment is viewed as a settlement of the vested options. Therefore, A should recognize in
equity the amount of cash paid to settle the options up to the fair-value-based measure of the options. See the
journal entry below.
Journal Entry: January 1, 20X3 — Date of Separation Agreement
APIC 400,000
Cash 400,000
To record the repurchase of the vested options on the date of
the separation agreement (10,000 options × $40 fair-value-based
measure as of the date of the separation agreement).
Unvested Options
Since the executive’s unvested options are no longer expected to vest as of the date of the separation
agreement, A should reverse any previously recognized compensation cost associated with these options on
the date of the separation agreement. The termination payment is then treated as an improbable-to-probable
modification of the unvested options. Accordingly, the total fair-value-based measure of the unvested options
is zero immediately before the date of the separation agreement (0 options expected to vest × $42 fair-value-
based measure of the unvested options as of the date of the separation agreement). The cash paid for the
unvested options is $600,000, which is the total amount of cash paid for the vested and unvested options
($1 million) less the fair-value-based measure of the vested options ($400,000). Therefore, A recognizes the
$600,000 settlement of the unvested options as compensation cost on the date of the separation agreement.
See the journal entries below.
Journal Entries: January 1, 20X3 — Date of Separation Agreement
APIC 175,000
To reverse any previously recognized compensation cost associated
with the unvested options that are no longer expected to vest
(10,000 options × $35 grant-date fair-value-based measure × 50%
for two of four years of services rendered).
323

Cash 600,000
To record incremental compensation cost resulting from the
settlement on the date of the separation agreement ($1 million
cash paid less the fair-value-based measure of the vested options
as of the date of the separation agreement).
6.10.2 Cash Settlements Versus Modifications

As discussed in Section 6.7, modification accounting generally applies to short-term inducements
(1) to which the award holder can subscribe for a limited period and (2) that are accepted by the award
holder. However, the accounting consequences could be considerably different depending on whether
the repurchase of an equity-classified share-based payment award for cash or other assets in the
future constitutes (1) a short-term offer that is, in substance, a settlement of the equity award or (2) a
modification of the equity award that changes the award’s classification from equity to liability followed
by a settlement of the now liability-classified award.
If the repurchase of (or offer to repurchase) the equity award is considered a settlement, the
requirements of ASC 718-20-35-7 apply. That is, as long as the settlement consideration (cash, other
assets, or liabilities incurred) does not exceed the fair-value-based measure of the equity award as of
the settlement date, no additional compensation cost is recorded. The amount of cash, other assets,
or liabilities incurred to settle an award is charged directly to equity. To the extent that the settlement
consideration exceeds the fair-value-based measure of the equity award on the settlement date, that
difference is recognized as additional compensation cost.
Alternatively, if the repurchase of (or offer to repurchase) the equity award is considered a modification
that changes the award’s classification from equity to liability followed by a subsequent settlement of
the now liability-classified award, an entity may need to recognize additional compensation cost as of
the modification date on the basis of the fair-value-based measure of the liability award. That is, upon
changing the award’s classification from equity to liability, an entity would adjust the carrying value of
the equity award to its then-current fair-value-based measure as a share-based liability. Additional
compensation cost would be recorded if the fair-value-based measure of the liability award on the
modification date is greater than the original grant-date fair-value-based measure of the equity award.
(See Section 6.8.1 for a more detailed discussion of the accounting for a modification that changes
an award’s classification from equity to liability.) Because the award is now a share-based liability, the
entity would remeasure it at its fair-value-based amount in each reporting period until settlement. (See
Chapter 7 for a more detailed discussion of the accounting for liability awards.) In addition, the amount
of cumulative compensation cost recognized cannot be less than the original grant-date fair-value-based
measure. When the cash is paid to settle the liability award at an amount equal to its fair value, the
share-based liability is settled with a corresponding credit to cash.
An entity must determine whether to account for a repurchase transaction in which it offers to settle
the equity award for cash or other assets (or liabilities incurred) on some future date as a settlement or
a modification of the equity award. The FASB clarified in FSP FAS 123(R)-6 that its intent was not for an
award’s classification to change from equity to liability as a result of an offer to repurchase the award for
a limited period. Paragraph 11 of FSP FAS 123(R)-6 states, in part:
The Board did not intend for a short-term inducement that is deemed to be a settlement to affect the
classification of the award for the period it remains outstanding (for example, change the award from an equity
324
instrument to a liability instrument). Therefore, an offer (for a limited time period) to repurchase an award
should be excluded from the definition of a short-term inducement and should not be accounted for as a
modification pursuant to paragraph 52 of Statement 123(R) [codified in ASC 718-20-35-5].
Entities should use judgment to determine whether an offer to repurchase an equity award is
outstanding for more than a “limited time period”; that is, whether the repurchase of the equity award
should be accounted for as (1) a short-term offer that is, in substance, a settlement of the equity award
or (2) a modification of the equity award followed by the settlement of a liability award.
The following are among the items an entity should consider in determining whether an offer to
repurchase an award that has been accepted by the holder is a modification that changes the award’s
classification from equity to liability:
• The amount that would be paid to settle the awards continues to be indexed to the grantor’s
equity (i.e., the settlement amount is not fixed or determinable).
• Whether substantive future service is required.

Note that if an entity’s practice or intent is to repurchase (or offer to repurchase) equity awards, it should
evaluate the substantive terms of all outstanding share-based payment awards in accordance with ASC
718-10-25-15. An entity’s consistent pattern of cash settling, or its intent to cash settle, awards may
suggest that its outstanding awards’ substantive terms permit cash settlement and therefore require
liability classification. This concept was emphasized in paragraph 11 of FSP FAS 123(R)-6, which states, in
part:
[I]f an entity has a history of settling its awards for cash, the entity should consider whether at the inception of the
awards it has a substantive liability pursuant to paragraph 34 of Statement 123(R) [codified in ASC 718-10-25-15].
Account for the transaction as (1) Does the Account for transaction as a
a short-term offer that is, in obligation continue modification that changes the
substance, a settlement of the No to be indexed to the Yes
award’s classification from
equity award. grantor’s equity or (2) is equity to liability.
(Section 6.10.1) substantive future
service required?5 (Section 6.8.1)
Adjust the carrying value of the

equity award to its then-current
Is the cash fair-value-based measure as
settlement less a share-based liability on the
than or equal to the No Recognize the amount in excess of modification date and remeasure
fair-value-based measure the fair-value-based measure as at the end of each reporting
of the vested awards additional compensation cost. period.
on the repurchase
date?
Yes
Recognize as a charge to equity

the amount paid to repurchase
the vested awards.
5
Note that these are two key factors that must be considered; however, an entity must evaluate all relevant facts and circumstances as part of this
assessment.
325
Example 6-31
On January 1, 20X1, Entity A granted 1,000 at-the-money employee stock options, each with a grant-date fair-
value-based measure of $10. Throughout the options’ life, they are classified as equity. After the options are
fully vested, A offers to repurchase them for cash equal to their then-current fair-value-based measure ($12 per
option). If the offer to repurchase the options is considered a settlement, because, for example, the options will
be settled immediately, the entire $12,000 (1,000 options × $12 fair-value-based measure on the settlement
date) will be charged to equity, with the corresponding credit to cash. See the journal entry below.
Journal Entry: At Settlement
APIC ($12 × 1,000 options) 12,000

Cash 12,000
To record the cash paid to settle the employee share options at their
then-current fair-value-based measure.
Alternatively, if the offer to repurchase the options is considered a modification because, for example, the
options will be settled in one year for cash on the basis of their fair-value-based measure at that time, the
options are first reclassified as a share-based liability, and the difference ($2) between the grant-date fair-value-
based measure ($10) and the current fair-value-based measure ($12) is recorded as additional compensation
cost. Because the award is now a share-based liability, the entity would remeasure it at its fair-value-based
amount in each reporting period until settlement, which is $15 per option one year later (the fair-value-based
measure at that time). When the cash is paid to settle the liability award, the share-based liability is settled with
a corresponding credit to cash. See the journal entries below.
Journal Entry: At Modification
APIC ($10 × 1,000 options) 10,000

Share-based liability ($12 × 1,000 options) 12,000
To reclassify the grant-date fair-value-based measure recorded
in equity as a share-based liability and record the additional
compensation cost.
Journal Entries: At Settlement

To remeasure the liability award at the fair-value-based amount
[(1,000 options × $15 fair-value-based measure) – $12,000 share-
based liability previously recognized].

Cash 15,000
To record the cash paid to settle the employee stock options at the
fair-value-based measure of the share-based liability.
326
In some cases, the repurchase of an equity-classified share-based payment award for cash constitutes
both (1) a settlement and (2) a modification that changes the award’s classification to a liability. For
example, an entity may modify an award to require cash settlement but subject only a portion of the
cash payment to vesting, or it may pay a large, nonrecurring cash dividend to all award holders in
connection with an equity restructuring but, for unvested awards, subject a portion of the cash dividend
to vesting. The accounting for large, nonrecurring cash dividends is different from that in ASC 718 for
dividend protected awards (see Section 3.10) because such dividends meet the definition of an equity
restructuring (see Section 6.5). Exchanges of stock options or other equity instruments or changes to
their terms in conjunction with an equity restructuring are modifications and therefore subject to the
accounting guidance in ASC 718-20-35-2A. Further, a “large, nonrecurring dividend” is not defined in U.S.
GAAP; therefore, an entity should apply judgment when determining whether a dividend gives rise to an
equity restructuring transaction and modification accounting under ASC 718. An entity may wish to seek
the opinion of legal counsel when determining whether a dividend represents an equity restructuring
that triggers a nondiscretionary antidilution provision.
In these circumstances, the cash payment should be allocated to (1) the portion of the awards that has
been settled and (2) the portion of the awards that has been modified.
Example 6-31A
On January 1, 20X1, Entity A granted to an employee 1,000 equity-classified RSUs, each with a grant-date
fair-value-based measure of $10. The RSUs vest on a graded basis over four years (25 percent each year on
December 31). Entity A has a policy of recognizing compensation cost on a straight-line basis over the total
requisite service period of four years and has therefore recognized compensation cost of $2,500 each year.
On January 1, 20X3, A declares a large, nonrecurring cash dividend of $5 per share which meets the definition of
an equity restructuring. The RSUs have (1) a nondiscretionary antidilution provision that requires an equitable
adjustment or payment in the event of an equity restructuring (and therefore are subject to the modification
accounting guidance in ASC 718-20-35-2A) and (2) a fair-value-based measure of $20 per RSU on January 1,
20X3 (the $20 value includes the value of the $5 dividend), both immediately before and after the modification.
Each RSU is entitled to the cash dividend, including the unvested RSUs that are subject to continued vesting on
the basis of their original vesting terms.
One acceptable approach is to separately account for the fully vested RSUs and the unvested RSUs (which
have two years of remaining service). Therefore, for 500 of the RSUs that are fully vested, there is a partial
cash settlement for 25 percent of the RSUs ($5 dividend per share ÷ $20 fair-value-based measure per RSU on
January 1, 20X3). For the 500 unvested RSUs, there is a partial modification from an equity-classified award to a
liability-classified award for 25 percent of the RSUs; the remaining 75 percent of the RSUs are deemed not to be
settled or modified. The journal entries and related calculations below illustrate this approach to accounting for
the partial cash settlement and modification.

Dividend payable 2,500
To record the dividend payable to partially settle the fully vested RSUs
($5 dividend per share × 500 RSUs).
327
Example 6-31A (continued)
Compensation cost 1,875*

APIC 1,875
To record remaining compensation cost associated with the equity-
classified award for each of the years ended December 31, 20X3
and 20X4 ($10 original grant-date fair-value-based measure per
RSU × 500 RSUs × 75% × 50% of remaining service rendered each
year).
Compensation cost 1,250*

Compensation payable 1,250
To record compensation cost associated with the liability-classified
award for each of the years ended December 31, 20X3 and 20X4
($5 dividend per share × 500 RSUs × 50% of remaining service
rendered each year).
* In the absence of the modification, compensation cost for the years ended December 31, 20X3 and 20X4, would have been
$5,000 ($10 grant-date fair-value-based measure × 1,000 RSUs × 50% of remaining service rendered). The incremental
compensation cost associated with the partial modification is therefore $1,250, or ($1,875 × 2) + ($1,250 × 2) – $5,000.
6.11 Cancellations
ASC 718-20
Cancellation and Replacement

35-8 Except as described in paragraph 718-20-35-2A, cancellation of an award accompanied by the concurrent
grant of (or offer to grant) a replacement award or other valuable consideration shall be accounted for as a
modification of the terms of the cancelled award. (The phrase offer to grant is intended to cover situations in
which the service inception date precedes the grant date.) Therefore, incremental compensation cost shall be
measured as the excess of the fair value of the replacement award or other valuable consideration over the fair
value of the cancelled award at the cancellation date in accordance with paragraph 718-20-35-3. Thus, the total
compensation cost measured at the date of a cancellation and replacement shall be the portion of the grant-
date fair value of the original award for which the promised good is expected to be delivered (or has already
been delivered) or the service is expected to be rendered (or has already been rendered) at that date plus the
incremental cost resulting from the cancellation and replacement.
35-9 A cancellation of an award that is not accompanied by the concurrent grant of (or offer to grant)
a replacement award or other valuable consideration shall be accounted for as a repurchase for no
consideration. Accordingly, any previously unrecognized compensation cost shall be recognized at the
cancellation date.
A cancellation may be accompanied by a concurrent grant of (or offer to grant) a new (or replacement)
award. Because the entity is in effect granting (or offering to grant) an award to replace the canceled
award, a cancellation accompanied by a concurrent grant of (or offer to grant) a replacement award is
accounted for in the same manner as a modification. That is, the entity must record the incremental
value, if any, conveyed to the holder of the award as compensation cost on the cancellation date (for
vested awards) or over the remaining employee requisite service period or nonemployee’s vesting
period (for unvested awards). The incremental compensation cost is the excess of the fair-value-based
measure of the replacement award over the fair-value-based measure of the canceled award on the
cancellation date.
328
By contrast, a cancellation without a concurrent replacement is viewed as the settlement of an award for
no consideration. As a result, if an entity (or grantee) cancels an unvested award without a replacement
award, any remaining unrecognized compensation cost would generally be recognized immediately
on the cancellation date. Note that a cancellation differs from a forfeiture. As discussed in Section
3.4.1, a forfeiture represents an award for which the employee’s requisite service is not rendered or
the nonemployee’s goods or services are not delivered (e.g., because of termination of employment or
termination of an arrangement with a nonemployee). Therefore, an award that will not vest because
of the grantee’s inability to satisfy a service condition is accounted for as a forfeiture rather than as a
cancellation.
A cancellation, however, represents an award for which the employee’s requisite service is expected
to be rendered or the nonemployee’s goods or services is expected to be provided but is canceled.
Accordingly, for a forfeiture, an entity reverses any compensation cost that it has previously recognized,
whereas it does not reverse any previously recognized compensation for a cancellation. As noted above,
any remaining unrecognized compensation cost is generally recognized immediately on the cancellation
date.
Example 6-32
fair-value-based measure of $9. The options vest at the end of the fourth year of service (cliff vesting). On
January 1, 20X4, A cancels the options and concurrently issues replacement options. The service period of the
replacement options covers the remaining one-year service period of the canceled options. The fair-value-
based measure of the replacement award is $7, and the fair-value-based measure of the canceled award is $4
on the date of cancellation.
During the first three years of service, A records cumulative compensation cost of $6,750 (1,000 options × $9
grant-date fair-value-based measure × 75% for three of four years of services rendered). On the cancellation
date (i.e., the modification date), A computes the incremental compensation cost as $3,000, or ($7 fair-value-
based measure of replacement options – $4 fair-value-based measure of canceled options on the date of
cancellation) × 1,000 options. The $3,000 incremental compensation cost is recorded over the remaining year of
service of the replacement options. In addition, A records the remaining $2,250 of compensation cost over the
remaining year of service attributable to the canceled options. Therefore, total compensation cost associated
with these options is $12,000 ($9,000 grant-date fair-value-based measure + $3,000 incremental fair-value-
based measure) recorded over four years of required service for both the canceled and replacement options.
Example 6-33
Assume all the same facts as in the example above, except that Entity A cancels the original options with no
concurrent issuance of (or offer to issue) replacement options. Six months later, A issues 1,000 new at-the-
money employee stock options, each with a grant-date fair-value-based measure of $12. The options vest over
the remaining six-month service period attributable to the canceled options.
During the first three years of service, A records cumulative compensation cost of $6,750 (1,000 options × $9
grant-date fair-value-based measure × 75% for three of four years of services rendered). On the cancellation
date, the options are treated as though they are fully vested. Accordingly, A records the remaining $2,250 of
compensation cost attributable to the canceled options. Therefore, total compensation cost associated with
the canceled options is the $9,000 grant-date fair-value-based measure.
For the options issued six months later, A records $12,000 (1,000 options × $12 grant-date fair-value-based
measure) of compensation cost over the remaining six-month service period of the options. Therefore, total
compensation cost associated with these options is the $12,000 grant-date fair-value-based measure.
329
Because A did not account for the cancellation of the original options and issuance of the new options as a
cancellation and concurrent replacement (and therefore did not apply modification accounting), A records total
compensation cost of $21,000 (i.e., $9,000 for the canceled options and $12,000 for the options issued six
months later). By contrast, if A had canceled and replaced the original options concurrently for options worth
$12 per option (and therefore modification accounting was applied), A would record only total compensation
cost of $17,000, which is equal to the grant-date fair-value-based measure of the canceled options ($9,000)
and the incremental value conveyed to the holders of the replacement options ($8,000), or ($12 fair-value-
based measure of replacement options – $4 fair-value-based measure of canceled options on the date of
cancellation) × 1,000 options.
Example 6-33A
Assume all the same facts as in Example 6-32, except that on January 1, 20X4, Entity A’s stock price is
significantly less than the strike price, and the options are out-of-the-money. In addition, the grantee (an
executive-level officer) voluntarily agrees to cancel all 1,000 stock options because they are not material to
the executive’s overall compensation and she would like the shares to be used to grant new employee awards
under A’s stock incentive plan (rather than modifying the existing award to adjust the options’ strike price).
The “return” of the options is voluntary; it is not caused by the employee’s inability to satisfy the service
condition and vest in the awards (i.e., employment was not terminated, and it is assumed that the requisite
services would have otherwise been rendered over the vesting period). Therefore, the return of the unvested
options is treated as a cancellation rather than a forfeiture. As a result, the remaining unrecognized
compensation cost of $2,250 (remaining 25 percent of compensation cost that would have been recognized in
20X4) is recognized upon cancellation of the options, and the previously recorded compensation cost of $6,750
is not reversed.
6.12 Modifications That Change the Scope of Awards

An entity may modify or settle a liability to a grantee that is not subject to the provisions of ASC 718
by issuing awards that are subject to ASC 718 (e.g., stock options are granted in place of a cash-based
profit-sharing arrangement). If a liability that was not initially within the scope of ASC 718 is modified or
settled through the issuance of a new instrument that is within the scope of ASC 718, the entity should
account for the transaction, as well as the new award, under ASC 718.
Example 6-34
On January 1, 20X1, Entity A entered into a long-term incentive agreement with its CFO. The earliest date on
which the CFO would be entitled to receive payment under the agreement is 10 years from the date of the
agreement (January 1, 20Y1). Entity A accounts for the plan in accordance with ASC 710-10-25-9 and recognizes
the cost of the agreement in a systematic and rational manner over this 10-year period.
On January 1, 20X6, A and the CFO agree to terminate the agreement in exchange for A’s granting the CFO
options to purchase A’s common stock. The number of stock options that will be granted is determined on the
basis of the value of the long-term incentive agreement on the date of the exchange.
The value of the long-term incentive agreement on January 1, 20X6, was determined to be $2 million. The
number of stock options to be issued to the CFO on that date was based on the fair-value-based measure
of each stock option, determined by using an appropriate pricing model, and the $2 million value of the
agreement. The stock options will vest after the CFO’s fifth year of service (cliff vesting). As of January 1, 20X6, A
had recorded cumulative compensation cost and an accrued liability of $1 million associated with the long-term
incentive agreement because 50 percent (for 5 of 10 years of services rendered) of the required service period
had been rendered.
330
Although the accounting for the original agreement was not within the scope of ASC 718, such guidance is
relevant in the determination of the cost of the share-based payment awards (whether newly granted or as a
replacement of a prior compensation arrangement).
Therefore, A should reclassify the $1 million accrued liability as equity (APIC) and should record the difference
between the $2 million aggregate fair-value-based measure of the stock options and the $1 million of cumulative
compensation cost previously recognized in connection with the long-term incentive agreement ($1 million) as
compensation cost over the remaining five-year service period of the stock options. See the journal entries below.
Accrued liability 1,000,000

APIC 1,000,000
To reclassify the amount previously recorded as an accrued liability
related to the long-term incentive agreement as equity (APIC) on
the modification date.
Journal Entry: December 31, 20X6, Through December 31, 20Y0

APIC 200,000
To record compensation cost for each year from December 31, 20X6,
to December 31, 20Y0, for the replacement stock options.
6.13 Modifications When a Holder Is No Longer an Employee, a Nonemployee

Is No Longer Providing Goods or Services, or a Grantee Is No Longer a
Customer
ASC 718-10
Awards May Become Subject to Other Guidance

331
following:
conditions are met:
manner.
35-11 Other modifications of that instrument that take place after a nonemployee vests in the award and is no
longer providing goods or services, or a grantee 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.
332
ASC 718-10-35-10 indicates that a share-based payment award that is subject to ASC 718 does not
become subject to other applicable GAAP unless the award is modified when the individual is no longer
an employee or, for nonemployee awards, the award is vested and the individual is no longer providing
goods or services or, for customers, the award is vested and the grantee is no longer a customer.
Modifications made to an award when the holder is no longer an employee should be accounted for
under ASC 718-10-35-11, which refers to ASC 718-10-35-14. If the modification or a settlement does
not apply equally to all financial instruments of the same class regardless of whether the holder is (or
was) an employee, a nonemployee providing goods or services, or a customer, the above sections on
modifications and settlements apply, and any incremental fair-value-based measure is recognized as
compensation cost. After the modification, the award will become subject to other applicable GAAP
(e.g., ASC 815 and ASC 480). Note that once the award becomes subject to other applicable GAAP, ASC
718’s guidance on classification (including the exceptions to liability classification) no longer applies. See
Section 5.8 for further discussion of the accounting for awards that become subject to other guidance.
However, in accordance with ASC 718-10-35-10A, if the terms of an award are modified solely to
reflect an equity restructuring, the award is not subject to other applicable GAAP as long as both of the
following conditions are met:
manner.
333
Chapter 7 — Liability-Classified Awards
This chapter discusses the accounting for share-based payment awards that require liability
classification under ASC 718. Unlike equity-classified awards, liability-classified awards must be
remeasured at the end of each reporting period until settlement. By contrast, equity-classified awards
are measured at their fair-value-based amount (or, for nonpublic entities, at a calculated value if a fair-
value-based measure is not reasonably estimable) on the grant date (i.e., the award’s fair-value-based
measure is fixed on the grant date). In addition, because the measurement date for liability-classified
awards is the settlement date, the related income tax effects are remeasured at the end of each
reporting period until settlement.
7.1 Fair-Value-Based Measurement
ASC 718-10
55-9 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.
ASC 718-30
Measurement Objective and Measurement Date

Public Entity
30-1 At the grant date, the measurement objective for liabilities incurred under share-based compensation
arrangements is the same as the measurement objective for equity instruments awarded to grantees as
described in paragraph 718-10-30-6. However, the measurement date for liability instruments is the date of
settlement.
Nonpublic Entity
30-2 A nonpublic entity shall make a policy decision of whether to measure all of its liabilities incurred
under share-based payment arrangements (for employee and nonemployee awards) issued in exchange
for distinct goods or services at fair value or at intrinsic value. However, a nonpublic entity shall initially
and subsequently measure awards determined to be consideration payable to a customer (as described in
paragraph 606-10-32-25) at fair value.
Measurement
35-1 The fair value of liabilities incurred in share-based payment transactions shall be remeasured at the end
of each reporting period through settlement.
334
35-2 Changes in the fair value (or intrinsic value for a nonpublic entity that elects that method) of a liability
incurred under a share-based payment arrangement issued in exchange for goods or services that occur
during the employee’s requisite service period or the nonemployee’s vesting period shall be recognized as
compensation cost over that period. The percentage of the fair value (or intrinsic value) that is accrued as
compensation cost at the end of each period shall equal the percentage of the requisite service that has been
rendered for an employee award or the percentage that would have been recognized had the grantor paid
cash for the goods or services instead of paying with a nonemployee award at that date. Changes in the fair
value (or intrinsic value) of a liability issued in exchange for goods or services that occur after the end of the
employee’s requisite service period or the nonemployee’s vesting period are compensation cost of the period
in which the changes occur. Any difference between the amount for which a liability award issued in exchange
for goods or services is settled and its fair value at the settlement date as estimated in accordance with the
provisions of this Subtopic is an adjustment of compensation cost in the period of settlement. Example 1 (see
paragraph 718-30-55-1) provides an illustration of accounting for a liability award issued in exchange for service
from the grant date through its settlement.
Public Entity
35-3 A public entity shall measure a liability award under a share-based payment arrangement based on the
award’s fair value remeasured at each reporting date until the date of settlement. Compensation cost for each
period until settlement shall be based on the change (or a portion of the change, depending on the percentage
of the requisite service that has been rendered for an employee award or the percentage that would have
been recognized had the grantor paid cash for the goods or services instead of paying with a nonemployee
award at the reporting date) in the fair value of the instrument for each reporting period. Example 1 (see
paragraph 718-30-55-1) provides an illustration of accounting for an instrument classified as a liability using the
fair-value-based method.
Nonpublic Entity
The measurement objective for liability-classified awards is the same as that for equity-classified awards.
(See Chapter 4 for a detailed discussion of how the fair-value-based measure of share-based payment
award is determined.) For public entities, liability-classified awards must be measured at their fair-
value-based amount, which is the same measurement method required for equity-classified awards.
However, since the measurement date for liability-classified awards is the date of settlement rather than
the grant date for equity-classified awards, liability-classified awards are remeasured at their fair-value-
based amount at the end of each reporting period until settlement. As discussed in Section 4.13.3 and
Section 7.3, nonpublic entities can make a policy decision to elect, as an alternative to a fair-value-based
measure, to measure liability-classified awards issued in exchange for goods or services at intrinsic value.
If a nonpublic entity elects to measure its liability-classified awards issued in exchange for goods or
services at intrinsic value, those awards must still be remeasured at the end of each reporting period
until settlement. However, the use of the intrinsic-value method reduces the burden of calculating
a fair-value-based measure for options and similar instruments at the end of each reporting period.
For example, if an entity grants SARs that it classifies as a liability and calculates by using a fair-value-
based measurement, it will be required to use a valuation technique such as an option pricing model
and update the assumptions at the end of each reporting period. See Section 4.9 for a more detailed
discussion of selecting a valuation technique.
335
7.2 Recognition
As indicated in Section 7.1, the fair-value-based measure (or intrinsic value for a nonpublic entity that
elects that method for awards issued in exchange for goods or services) of a share-based payment
award that is classified as a liability is remeasured at the end of each reporting period until settlement.
Therefore, for all liability-classified awards, the settlement amount will ultimately be the total amount
of compensation cost recognized. The changes in the fair-value-based measure (or intrinsic value)
are recognized as compensation cost (with a corresponding increase or decrease in the share-based
liability) either immediately or over the remaining employee’s requisite service period or nonemployee’s
vesting period, depending on the vested status of the award. For unvested awards, the percentage of
the fair-value-based measure (or intrinsic value) that is recognized as compensation cost at the end
of each period is based on (1) the percentage of the requisite service that has been rendered for an
employee award or (2) the percentage that would have been recognized had the grantor paid cash for
the goods or services instead of paying with a share-based payment award as of that date.
7.2.1 Cash-Settled SARs
The example in ASC 718-30 below illustrates the accounting for a cash-settled stock appreciation right
associated with an award that is recognized on the basis of its fair-value-based measure. The example
also illustrates how the classification of a share-based payment award affects the accounting for income
taxes.
ASC 718-30
Illustrations
Example 1: Cash-Settled Stock Appreciation Right
55-1 This Example illustrates the guidance in paragraphs 718-30-35-2 through 35-4 and 718-740-25-2 through 25-4.
attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, the concepts about
valuation and forfeiture estimation and remeasurement of awards, exercise, and expiration in paragraphs 718-30-
55-2 through 55-11 are equally applicable to nonemployee awards with the same features as the awards in this
Example (that is, awards with a specified period of time for vesting classified as liabilities). Therefore, the guidance in
those paragraphs may serve as implementation guidance for similar nonemployee awards.
awards. 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 this Example 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 payment transactions.
55-2 Entity T, a public entity, grants share appreciation rights with the same terms and conditions as those
described in Example 1 (see paragraph 718-20-55-4). As in Example 1, Case A, Entity T makes an accounting
policy election in accordance with paragraph 718-10-35-3 to estimate the number of forfeitures expected
to occur and includes that estimate in its initial accrual of compensation costs. Each stock appreciation right
entitles the holder to receive an amount in cash equal to the increase in value of 1 share of Entity T stock over
$30. Entity T determines the grant-date fair value of each stock appreciation right in the same manner as a
share option and uses the same assumptions and option-pricing model used to estimate the fair value of
the share options in that Example; consequently, the grant-date fair value of each stock appreciation right is
$14.69 (see paragraphs 718-20-55-7 through 55-9). The awards cliff-vest at the end of three years of service
(an explicit and requisite service period of three years). The number of stock appreciation rights for which the
requisite service is expected to be rendered is estimated at the grant date to be 821,406 (900,000 × .973). Thus,
the fair value of the award as of January 1, 20X5, is $12,066,454 (821,406 × $14.69). For simplicity, this Example
assumes that estimated forfeitures equal actual forfeitures.
336
55-3 Paragraph 718-30-35-4 permits a nonpublic entity to measure share-based payment liabilities at either
fair value (or, in some cases, calculated value) or intrinsic value. If a nonpublic entity elects to measure those
liabilities at fair value, the accounting demonstrated in this Example would be applicable. Paragraph 718-30-35-3
requires that share-based compensation liabilities be recognized at fair value or a portion thereof (depending on
the percentage of requisite service rendered at the reporting date) and be remeasured at each reporting date
through the date of settlement; consequently, compensation cost recognized during each year of the three-year
vesting period (as well as during each year thereafter through the date of settlement) will vary based on changes
in the award’s fair value. As of December 31, 20X5, the assumed fair value is $10 per stock appreciation right;
hence, the fair value of the award is $8,214,060 (821,406 × $10). The share-based compensation liability as of
December 31, 20X5, is $2,738,020 ($8,214,060 ÷ 3) to account for the portion of the award related to the service
rendered in 20X5 (1 year of the 3-year requisite service period). For convenience, this Example assumes that
journal entries to account for the award are performed at year-end. The journal entries for 20X5 are as follows.


55-4 As of December 31, 20X6, the fair value is assumed to be $25 per stock appreciation right; hence, the
award’s fair value is $20,535,150 (821,406 × $25), and the corresponding liability at that date is $13,690,100
($20,535,150 × 2/3) because service has been provided for 2 years of the 3-year requisite service period.
Compensation cost recognized for the award in 20X6 is $10,952,080 ($13,690,100 – $2,738,020). Entity T
recognizes the following journal entries for 20X6.

To recognize a share-based compensation liability of $13,690,100
and associated compensation cost.

To recognize the deferred tax asset for the additional compensation
cost ($10,952,080 × .35 = $3,833,228).
337
55-5 As of December 31, 20X7, the fair value is assumed to be $20 per stock appreciation right; hence, the
award’s fair value is $16,428,120 (821,406 × $20), and the corresponding liability at that date is $16,428,120
($16,428,120 × 1) because the award is fully vested. Compensation cost recognized for the liability award in
20X7 is $2,738,020 ($16,428,120 – $13,690,100). Entity T recognizes the following journal entries for 20X7.

To recognize a share-based compensation liability of $16,428,120
and associated compensation cost.

To recognize the deferred tax asset for the additional compensation
cost ($2,738,020 × .35 = $958,307).
55-6 The share-based liability award is as follows.
Total Value of Award at Cumulative

Year Year-End Pretax Cost for Year Pretax Cost
20X5 $8,214,060 (821,406 × $10) $2,738,020 ($8,214,060 ÷ 3) $ 2,738,020
20X6 $20,535,150 (821,406 × $25) $10,952,080 [(20,535,150 × 2/3) – $2,738,020] $ 13,690,100
20X7 $16,428,120 (821,406 × $20) $2,738,020 ($16,428,120 – $13,690,100) $ 16,428,120
55-7 For simplicity, this Example assumes that all of the stock appreciation rights are exercised on the same
day, that the liability award’s fair value is $20 per stock appreciation right, and that Entity T has already
recognized its income tax expense for the year without regard to the effects of the exercise of the employee
stock appreciation rights. In other words, current tax expense and current taxes payable were recognized
based on taxable income and deductions before consideration of additional deductions from exercise of the
stock appreciation rights. The amount credited to cash for the exercise of the stock appreciation rights is equal
to the share-based compensation liability of $16,428,120.

Cash (821,406 × $20) $16,428,120
To recognize the cash payment to employees from stock
appreciation right exercise.
55-9 The cash paid to the employees on the date of exercise is deductible for tax purposes. The tax benefit is
$5,749,842 ($16,428,120 × .35).
338

To write off the deferred tax asset related to the stock appreciation
rights.

To adjust current tax expense and current taxes payable to recognize
the current tax benefit from deductible compensation cost.
55-11 If the stock appreciation rights had expired worthless, the share-based compensation liability account
and deferred tax asset account would have been adjusted to zero through the income statement as the
award’s fair value decreased.
Since a liability-classified SAR is remeasured at the end of each reporting period until settlement, the
settlement amount and ultimate amount of compensation cost recognized will generally be equal to the
award’s intrinsic value, even if recognized on the basis of its fair-value-based measure. This is because
upon settlement, there is no remaining time value. Therefore, the ultimate amount of compensation
cost recognized for a cash-settled SAR will be the same regardless of whether a nonpublic entity elects
to measure its liability-classified awards issued in exchange for goods or services on the basis of their
fair-value-based measure or intrinsic value. (See Section 7.3 for a discussion of the intrinsic-value
practical expedient available for nonpublic entities.) In addition, as noted in ASC 718-30-55-11, if a cash-
settled SAR is worthless at expiration, the ultimate amount of compensation cost recognized will be
zero. By contrast, an equity-classified stock option or SAR will be recognized at its grant-date fair-value-
based measure, and compensation cost cannot be reversed if the award is worthless at expiration as
long as the vesting conditions are met (i.e., the good is delivered or the service is rendered).
7.2.2 Liability-Classified Awards With Market Conditions

As discussed in Section 3.5, the effect of a market condition is reflected in the fair-value-based measure
of an award. If an award with a market condition is classified as equity, and the good is delivered or
the service is rendered, compensation cost is recognized regardless of whether the market condition
is satisfied. However, the same is not true for a liability-classified award that is earned only if a market
condition is satisfied. Because liability-classified awards are remeasured at the end of each reporting
period until settlement, the final compensation cost will be zero even if the good is delivered or the
service is rendered since the market condition has not been satisfied and therefore the award has not
been earned.
339
7.3 Intrinsic-Value Practical Expedient for Nonpublic Entities

ASC 718-30
Nonpublic Entity
Nonpublic Entity
As noted in Section 7.1, nonpublic entities can elect, as a policy decision, to measure liability-classified
awards issued in exchange for goods or services at intrinsic value instead of a fair-value-based measure
(or at a calculated value if a fair-value-based measure is not reasonably estimable) as of the end of each
reporting period until the awards are settled. To justify a change in accounting principle under ASC
250, it is preferable for a nonpublic entity to use the fair-value-based method (see Section 4.13.4 for a
discussion of how to record the effects of an entity’s change from nonpublic to public entity). Therefore,
a nonpublic entity that has elected to measure its liability-classified awards at a fair-value-based amount
(or calculated value) would not be permitted to subsequently change to the intrinsic-value method.
The example in ASC 718-30 below illustrates the use of the intrinsic-value method for measuring liability-
classified awards, which is available to nonpublic entities.
ASC 718-30
Example 2: Award Granted by a Nonpublic Entity That Elects the Intrinsic Value Method
55-12 This Example illustrates the guidance in paragraphs 718-30-35-4 and 718-740-25-2 through 25-4.
cost attribution and certain inputs to valuation, are the same for nonemployee awards. Consequently, a
nonpublic entity can make the accounting policy election in paragraph 718-30-30-2 to change its measurement
of all liability-classified nonemployee awards from fair value to intrinsic value and remeasure those awards
each reporting period as illustrated in this Example. Therefore, the guidance in this Example may serve as
implementation guidance for similar liability-classified nonemployee awards.
55-12B Compensation cost attribution for awards to nonemployees may be the same or different for
liability-classified employee awards. 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 this Example 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 payment transactions.
340
55-13 On January 1, 20X6, Entity W, a nonpublic entity that has chosen the accounting policy of using the
intrinsic value method of accounting for share-based payments that are classified as liabilities in accordance
with paragraphs 718-30-30-2 and 718-30-35-4, grants 100 cash-settled stock appreciation rights with a 5-year
life to each of its 100 employees. Each stock appreciation right entitles the holder to receive an amount in
cash equal to the increase in value of 1 share of Entity W’s stock over $7. The awards cliff-vest at the end
of three years of service (an explicit and requisite service period of three years). For simplicity, the Example
assumes that no forfeitures occur during the vesting period and does not reflect the accounting for income tax
consequences of the awards.
55-14 Because of Entity W’s accounting policy decision to use intrinsic value, all of its share-based payments
that are classified as liabilities are recognized at intrinsic value (or a portion thereof, depending on the
percentage of requisite service that has been rendered) at each reporting date through the date of settlement;
consequently, the compensation cost recognized in each year of the three-year requisite service period will
vary based on changes in the liability award’s intrinsic value. As of December 31, 20X6, Entity W stock is valued
at $10 per share; hence, the intrinsic value is $3 per stock appreciation right ($10 – $7), and the intrinsic value
of the award is $30,000 (10,000 × $3). The compensation cost to be recognized for 20X6 is $10,000 ($30,000
÷ 3), which corresponds to the service provided in 20X6 (1 year of the 3-year service period). For convenience,
this Example assumes that journal entries to account for the award are performed at year-end. The journal
entry for 20X6 is as follows.

stock appreciation right ($8 – $7), and the intrinsic value of the award is $10,000 (10,000 × $1). The decrease
in the intrinsic value of the award is $20,000 ($10,000 – $30,000). Because services for 2 years of the 3-year
service period have been rendered, Entity W must recognize cumulative compensation cost for two-thirds of
the intrinsic value of the award, or $6,667 ($10,000 × 2/3); however, Entity W recognized compensation cost of
$10,000 in 20X5. Thus, Entity W must recognize an entry in 20X7 to reduce cumulative compensation cost to
$6,667.

To adjust cumulative compensation cost ($6,667 – $10,000).
stock appreciation right ($15 – $7), and the intrinsic value of the award is $80,000 (10,000 × $8). The cumulative
compensation cost recognized as of December 31, 20X8, is $80,000 because the award is fully vested. The
journal entry for 20X8 is as follows.

To recognize compensation cost ($80,000 – $6,667).
341
55-17 The share-based liability award at intrinsic value is as follows.
Total Value of Award at Cumulative

Year Year-End Pretax Cost for Year Pretax Cost
20X6 $30,000 (10,000 × $3) $10,000 ($30,000 ÷ 3) $ 10,000
20X7 $10,000 (10,000 × $1) $(3,333) [(10,000 × 2/3) – $10,000] $ 6,667
20X8 $80,000 (10,000 × $8) $73,333 ($80,000 – $6,667) $ 80,000
55-18 For simplicity, this Example assumes that all of the stock appreciation rights are settled on the day that
they vest, December 31, 20X8, when the share price is $15 and the intrinsic value is $8 per share. The cash paid
to settle the stock appreciation rights is equal to the share-based compensation liability of $80,000.

Cash (10,000 × $8) $80,000
To recognize the cash payment to employees for settlement of stock
appreciation rights.
55-20 If the stock appreciation rights had not been settled, Entity W would continue to remeasure those
remaining awards at intrinsic value at each reporting date through the date they are exercised or otherwise
settled.
7.4 Modifications
ASC 718-30
Modification of an Award
35-5 A modification of a liability award is accounted for as the exchange of the original award for a new
award. However, because liability awards are remeasured at their fair value (or intrinsic value for a nonpublic
entity that elects that method) at each reporting date, no special guidance is necessary in accounting for
a modification of a liability award that remains a liability after the modification (see Example 15, Case C
[paragraph 718-20-55-135] for what happens when the modification causes the award to no longer be a
liability).
As discussed in Chapter 6, a modification is considered an exchange of an original award for a new

award. This principle also applies to liability-classified awards that are modified. Since liability-classified
awards are remeasured at the end of each reporting period until settlement, an entity accounts for a
modification by measuring the modified award at its fair-value-based amount (or intrinsic value for a
nonpublic entity that has elected that method for awards issued in exchange for goods or services) on
the modification date. If the award is unvested, the entity determines the cumulative compensation cost
to be recorded by calculating the award’s fair-value-based measure (or intrinsic value) and multiplying
this amount by the percentage of the requisite service that has been rendered for an employee award
or the percentage that would have been recognized had the grantor paid cash for the goods or services
instead of paying with a share-based payment award on the modification date. The entity then compares
(1) the cumulative compensation cost to be recorded for the modified award and (2) the cumulative
compensation cost recognized for the original award and records the difference as either an increase
or decrease in compensation cost. The implementation example in ASC 718-20 below illustrates the
342
accounting for the modification of a liability-classified award that remains a liability after the modification
and is based on the facts as described in ASC 718-30-55-1 through 55-11 (see Section 7.2.1).1
ASC 718-20
Example 16: Modifications Regarding an Award’s Classification

Case D: Liability to Liability Modification (Cash-Settled to Cash-Settled Stock Appreciation Rights)
55-139 This Case is based on the facts given in Example 1 (see paragraph 718-30-55-1). Entity T grants stock
appreciation rights to its employees. The fair value of the award on January 1, 20X5, is $12,066,454 (821,406 ×
$14.69).
55-140 On December 31, 20X5, the fair value of each stock appreciation right is assumed to be $5; therefore,
the fair value of the award is $4,107,030 (821,406 × $5). The share-based compensation liability at December
31, 20X5, is $1,369,010 ($4,107,030 ÷ 3), which reflects the portion of the award related to the requisite service
provided in 20X5 (1 year of the 3-year requisite service period). For convenience, this Case assumes that journal
entries to account for the award are performed at year-end. The journal entries to recognize compensation
cost for 20X5 are as follows.


55-141 On January 1, 20X6, Entity T reprices the stock appreciation rights, giving each holder the right to
receive an amount in cash equal to the increase in value of 1 share of Entity T stock over $10. The modification
affects no other terms or conditions of the stock appreciation rights and does not change the number of stock
appreciation rights expected to vest. The fair value of each stock appreciation right based on its modified
terms is $12. The incremental compensation cost is calculated per the method in Example 12 (see paragraph
718-20-55-93).
Fair value of modified stock appreciation right award (821,406 × $12) $ 9,856,872
Less: Fair value of original stock appreciation right (821,406 × $5) 4,107,030
Incremental value of modified stock appreciation right 5,749,842
Divide by three to reflect earned portion of the award ÷3
Compensation cost to be recognized $ 1,916,614
1
See ASC 718-20-55-122A through 55-122C for considerations related to the application of Example 16 to nonemployee awards.
343
55-142 Entity T also could determine the incremental value of the modified stock appreciation right award
by multiplying the fair value of the modified stock appreciation right award by the portion of the award that
is earned and subtracting the cumulative recognized compensation cost [($9,856,872 ÷ 3) – $1,369,010 =
$1,916,614]. As a result, Entity T would record the following journal entries at the date of the modification.

To recognize incremental compensation cost.

related to additional compensation cost ($1,916,614 × .35 =
$670,815).
55-143 Entity T would continue to remeasure the liability award at each reporting date until the award’s
settlement.
344
Chapter 8 — Employee Stock Purchase
Plans
8.1 Scope
ASC 718-50
General
05-1 This Subtopic provides guidance to entities that use employee share purchase plans. The entity must first
determine whether the plan is compensatory or noncompensatory. This is determined by the terms of the plan
(see paragraphs 718-50-25-1 through 25-2). A plan with an option feature, for example a look-back feature,
is considered compensatory. For a compensatory plan the calculation of the amount of the compensation is
important (see Section 718-50-55).
Overall Guidance
15-1 This Subtopic has its own discrete scope, which is separate and distinct from the pervasive scope for this
Topic as outlined in Section 718-10-15.
An ESPP is a plan that gives employees the ability to purchase an entity’s shares, typically at a discount.
Generally, employees contribute to the ESPP through payroll deductions over a period between the
enrollment date and purchase date (referred to as the purchase period). The accumulated payroll
withholdings are then used to purchase the entity’s shares on behalf of the participating employees.
The guidance on share-based payment transactions with ESPPs is contained in ASC 718-50 and is
separate and distinct from the general requirements in ASC 718, as outlined in ASC 718-10-15.
An ESPP may be considered compensatory or noncompensatory. The distinction is significant because it

affects whether an entity recognizes compensation cost for the ESPP. To qualify as a noncompensatory
plan and, therefore, not give rise to the recognition of compensation cost, an ESPP must meet certain
criteria, which are discussed in Section 8.2.
345
8.2 Noncompensatory Plans
ASC 718-50
General
25-1 An employee share purchase plan that satisfies all of the following criteria does not give rise to
recognizable compensation cost (that is, the plan is noncompensatory):
a. The plan satisfies either of the following conditions:
1. The terms of the plan are no more favorable than those available to all holders of the same class
of shares. Note that a transaction subject to an employee share purchase plan that involves a class
of equity shares designed exclusively for and held only by current or former employees or their
beneficiaries may be compensatory depending on the terms of the arrangement.
2. Any purchase discount from the market price does not exceed the per-share amount of share
issuance costs that would have been incurred to raise a significant amount of capital by a public
offering. A purchase discount of 5 percent or less from the market price shall be considered to
comply with this condition without further justification. A purchase discount greater than 5 percent
that cannot be justified under this condition results in compensation cost for the entire amount
of the discount. Note that an entity that justifies a purchase discount in excess of 5 percent shall
reassess at least annually, and no later than the first share purchase offer during the fiscal year,
whether it can continue to justify that discount pursuant to this paragraph.
b. Substantially all employees that meet limited employment qualifications may participate on an equitable
basis.
c. The plan incorporates no option features, other than the following:
1. Employees are permitted a short period of time — not exceeding 31 days — after the purchase price
has been fixed to enroll in the plan.
2. The purchase price is based solely on the market price of the shares at the date of purchase, and
employees are permitted to cancel participation before the purchase date and obtain a refund of
amounts previously paid (such as those paid by payroll withholdings).
25-2 A plan provision that establishes the purchase price as an amount based on the lesser of the equity
share’s market price at date of grant or its market price at date of purchase, commonly called a look-back plan,
is an example of an option feature that causes the plan to be compensatory. Similarly, a plan in which the
purchase price is based on the share’s market price at date of grant and that permits a participating employee
to cancel participation before the purchase date and obtain a refund of amounts previously paid contains an
option feature that causes the plan to be compensatory. Section 718-50-55 provides guidance on determining
whether an employee share purchase plan satisfies the criteria necessary to be considered noncompensatory.
Unless it meets all three conditions in ASC 718-50-25-1, an ESPP is compensatory and therefore gives
rise to the recognition of compensation cost.
8.2.1 First Condition in ASC 718-50-25-1

Under ASC 718-50-25-1(a), an ESPP must satisfy either of the following criteria:
• “The terms of the plan are no more favorable than those available to all holders of the same
class of shares.”
Meeting this criterion is uncommon because ESPPs often offer terms for the purchase of shares
that are more favorable than the terms available to all shareholders. To prevent an entity from
creating a separate class of shares solely to satisfy this condition, ASC 718-50-25-1(a)(1) contains
an anti-abuse provision, which states that “a transaction subject to an employee share purchase
plan that involves a class of equity shares designed exclusively for and held only by current or
former employees or their beneficiaries may be compensatory depending on the terms of the
arrangement.”
346
Chapter 8 — Employee Stock Purchase Plans
• A purchase discount, if it is greater than 5 percent, does not exceed the per-share amount of
share issuance costs that would be incurred to raise a significant amount of capital through a
public offering.
A purchase discount of 5 percent or less from the market price of the entity’s shares is a safe
harbor and does not result in a compensatory ESPP. Many IRC Section 423 plans, however,
offer a purchase discount of 15 percent from the market price of the entity’s shares. If an entity
can justify that the discount (e.g., the 15 percent discount permitted under IRC Section 423) is
equivalent to the share issuance costs that the entity would have incurred to raise a significant
amount of capital in a public offering, the ESPP may be considered noncompensatory (provided
that the plan meets the remaining conditions discussed below). AICPA Technical Q&As Section
4110.01 provides guidance on what amounts should be considered for inclusion in the share
issuance cost. It states, in part:
Such costs should be limited to the direct cost of issuing the security. Thus, there should be no
allocation of officers’ salaries, and care should be taken that legal and accounting fees do not include
any fees that would have been incurred in the absence of such issuance.
In addition, the entity must continue to justify the appropriateness of the discount percentage
(if greater than 5 percent) at least annually and no later than when it makes the first share
purchase offer during the fiscal year. If the entity is no longer able to justify a discount in excess
of 5 percent, subsequent grants using that discount rate would be considered compensatory
(unless the “terms of the plan are no more favorable than those available to all holders of the
same class of shares” and the other conditions in ASC 718-50-25-1 are satisfied). The inability
to justify a discount on a current offering would not affect the noncompensatory nature of
previous offerings. That is, an entity would not record compensation cost for purchase offers
made before the entity is unable to justify a discount in excess of 5 percent.
The application of the condition in ASC 718-50-25-1(a) is illustrated in the following implementation
guidance:
ASC 718-50
55-35 Another criterion is that the terms are no more favorable than those available to all holders of the
same class of shares. For example, Entity A offers all full-time employees and all nonemployee shareholders
the right to purchase $10,000 of its common stock at a 5 percent discount from its market price at the date
of purchase, which occurs in 1 month. The arrangement is not compensatory because its terms are no
more favorable than those available to all holders of the same class of shares. In contrast, assume Entity B
has a dividend reinvestment program that permits shareholders of its common stock the ability to reinvest
dividends by purchasing shares of its common stock at a 10 percent discount from its market price on the
date that dividends are distributed and Entity B offers all full-time employees the right to purchase annually
up to $10,000 of its common stock at a 10 percent discount from its market price on the date of purchase.
Entity B’s common stock is widely held; hence, many shareholders will not receive dividends totaling at least
$10,000 during the annual period. Assuming that the 10 percent discount cannot be justified as the per-share
amount of share issuance costs that would have been incurred to raise a significant amount of capital by a
public offering, the arrangement is compensatory because the number of shares available to shareholders
at a discount is based on the quantity of shares held and the amounts of dividends declared. Whereas, the
number of shares available to employees at a discount is not dependent on shares held or declared dividends;
therefore, the terms of the employee share purchase plan are more favorable than the terms available
to all holders of the same class of shares. Consequently, the entire 10 percent discount to employees is
compensatory. If, on the other hand, the 10 percent discount can be justified as the per-share amount of share
issuance costs that would have been incurred to raise a significant amount of capital by a public offering, then
the entire 10 percent discount to employees is not compensatory. If an entity justifies a purchase discount
in excess of 5 percent, it would be required to reassess that discount at least annually and no later than the
first share purchase offer during the fiscal year. If upon reassessment that discount is not deemed justifiable,
subsequent grants using that discount would be compensatory.
347
In the example in ASC 718-50-55-35 above, B offers its shareholders the ability to participate in a
dividend reinvestment program (DRIP) and offers its employees a 10 percent discount on purchases of
its common stock up to $10,000. Because the shareholders are not likely to receive dividends totaling
$10,000, their participation in the DRIP will not be the same as that of employees in the ESPP. That is,
while the terms of the ESPP (for employees) and the DRIP (for all other shareholders) are similar (i.e., B’s
shares may be purchased at a 10 percent discount from the market price), employees can participate in
the ESPP by contributing up to $10,000, whereas all other shareholders can participate in the DRIP by
contributing only up to the amount of dividends they receive, which may not total $10,000. Accordingly,
the terms available to employees under the ESPP may be more favorable.
The ESPP may still be noncompensatory with respect to the discounted shares offered to employees
if B can justify that the discount does not exceed the share issuance costs that the entity would have
incurred to raise a significant amount of capital in a public market (assuming the plan meets the
remaining conditions in ASC 718-50-25-1). However, as discussed above, the entity must continue to
assess the discount percent at least annually, and no later than the first ESPP offer during the fiscal year,
to justify continued use of the discount percentage on subsequent offerings.
Example 8-1
On January 1, 20X1, Entity A establishes an ESPP that permits employees to purchase A’s shares at a 7 percent
discount. Entity A can justify that the 7 percent discount is not greater than the costs A would have incurred
in a significant offering of A’s shares in a public market. Therefore, the ESPP is not considered compensatory
(provided that all the other criteria in ASC 718-50-25-1 also have been met).
On July 1, 20X1, A makes a second offering under its ESPP, also with a 7 percent discount. Entity A is not
required to reassess the 7 percent discount used in the second ESPP offering in 20X1. As long as all the other
criteria in ASC 718-50-25-1 continue to be met, the plan is not considered compensatory.
On January 1, 20X2, A makes a third offering under its ESPP and again offers a 7 percent discount. In
accordance with ASC 718-50-25-1(a)(2), A would have to justify that the 7 percent discount remains appropriate
for this offering. If, for this offering, A can no longer justify the 7 percent discount, the plan is considered
compensatory (unless the “terms of the plan are no more favorable than those available to all holders of the
same class of shares” and the other conditions in ASC 718-50-25-1 have been met). Entity A’s inability to justify
the discount on the current offering would not affect the noncompensatory nature of prior offerings. That is,
A would record no compensation cost for purchase offers made before A is unable to justify the discount (i.e.,
for the January 1, 20X1, and the July 1, 20X1, offerings). Further, for the third offering, A must include the entire
amount of the discount (i.e., 7 percent) in determining the amount of compensation cost over the requisite
service period, not just the discount in excess of 5 percent.
8.2.2 Second Condition in ASC 718-50-25-1

Under ASC 718-50-25-1(b), the ESPP must allow substantially all employees that meet limited
employment qualifications to participate on an equitable basis. ASC 718-50-55-34 provides examples of
limited employment qualifications as follows:
ASC 718-50
Example 2: Limitations for Noncompensatory Treatment

55-34 Paragraph 718-50-25-1 stipulates the criteria that an employee share purchase plan must satisfy to
be considered noncompensatory. One of those criteria specifies that substantially all employees that meet
limited employment qualifications may participate on an equitable basis. Examples of limited employment
qualifications might include customary employment of greater than 20 hours per week or completion of at least
6 months of service.
348
While an entity will assess whether it has satisfied this condition on the basis of its specific facts and
circumstances, the underlying principle is that the ESPP should be nondiscriminatory. For example, if
participation is limited to executives, and nonexecutives are not eligible to participate, the ESPP will not
meet this condition.
8.2.3 Third Condition in ASC 718-50-25-1

Under ASC 718-50-25-1(c), an entity assesses whether the ESPP incorporates option features and, if so,
whether they cause the plan to become compensatory. Except in the following two circumstances, an
option feature renders a plan compensatory:
• The option feature gives an employee “a short period of time — not exceeding 31 days —
after the purchase price has been fixed to enroll in the plan.” However, an ESPP with such a
feature may have an additional option feature that renders it compensatory. For example,
an ESPP would be compensatory if (1) the purchase price is set on the date the employee
begins to participate in the plan and is having money withheld to pay for the shares but (2) the
plan allows the employee to cancel participation after enrollment and receive a refund of the
amount previously withheld from the employee’s pay. This is because the employee begins to
benefit from, or be adversely affected by, subsequent changes in the entity’s share price once
the purchase price is set. Allowing cancellation of participation after enrollment would give the
employee benefits similar to those of a stock option.
• The “purchase price is based solely on the market price of the [entity’s] shares at the date
of purchase, and employees are permitted to cancel participation before the purchase date
and obtain a refund of amounts previously paid” (emphasis added). Unlike a scenario in which
the employee can cancel participation in the plan after the purchase price has been set (and
therefore after beginning to benefit from, or be adversely affected by, subsequent changes in
the entity’s share price), such an option feature does not give the employee benefits similar to
those of a stock option because the employee can only cancel participation before the purchase
price is set.
Note that many existing ESPPs include a look-back feature that allows the purchase price to be set at
the lower of (1) the market price of the entity’s shares on the date the employee begins participating in
the plan and is having money withheld to pay for the shares or (2) the market price of the shares on the
purchase date. A look-back feature is considered an option feature that results in a compensatory plan.
See discussion in Section 8.7.
8.3 Requisite Service Period

ASC 718-50
25-3 The requisite service period for any compensation cost resulting from an employee share purchase plan is
the period over which the employee participates in the plan and pays for the shares.
As with any other share-based payment award, if an ESPP is deemed to be compensatory, compensation
cost is recognized over the requisite service period. The service inception date is the date on which
the requisite service period begins and is usually the grant date, although there may be circumstances
in which the service inception date precedes the grant date. Given the guidance in ASC 718-50-25-3,
the requisite service period, and therefore the period over which compensation cost is recognized for
an ESPP, will typically be the purchase period, which may begin before or after the grant date (i.e., the
service inception date may not be the grant date).
349
If an ESPP contains multiple purchase periods, the award in effect has a graded vesting schedule.
Accordingly, an entity would record compensation cost in accordance with its policy on the treatment
of awards with only service conditions that have a graded vesting schedule. For such awards, ASC
718-10-35-8 allows entities to elect, as a policy decision, to recognize compensation cost on either
(1) an accelerated basis as though each separately vesting portion of the award was, in substance, a
separate award or (2) “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).” (See Section
3.6.5 for examples illustrating both methods.) An entity should consistently apply the method it elects
for recognizing compensation cost for awards with only a service condition that have a graded vesting
schedule.
Note that an entity’s ability to make a policy election regarding how to recognize compensation cost (i.e.,
on an accelerated or straight-line basis) is not affected by the technique it uses to value an ESPP award
or whether the technique may directly or indirectly result in the valuation of each portion of a graded
vesting award as an individual award. See Section 4.10 for a discussion of the interaction between
valuation techniques and the graded vesting attribution methods.
The examples below illustrate how to determine the requisite service period for different types of ESPPs.
Example 8-2
Recognizing Compensation Cost for an ESPP Over a Single Purchase Period

Entity A offers an ESPP to all eligible employees. To participate in the offering for the following year, A’s
employees must enroll by December 15, 20X1. On that date, all the terms of the ESPP (including the purchase
price) are determined, and a grant date is established in accordance with ASC 718. The purchase period for all
employees enrolled in the ESPP, which is the period in which actual payroll withholdings are made, is January 1,
20X2, through June 30, 20X2. In accordance with ASC 718-50-25-3, the requisite service period, and therefore
the period over which compensation cost will be recognized, is January 1, 20X2, through June 30, 20X2, even
though a grant date was established as of December 15, 20X1.
Example 8-3
Recognizing Compensation Cost for an ESPP With a Single Look-Back Feature Over Multiple
Purchase Periods
Assume the same facts as in the example above, except that Entity A gives its employees a two-year offering
period in which to purchase its shares on June 30, 20X2; December 31, 20X2; June 30, 20X3; and December
31, 20X3. The purchase price of A’s shares is based on a look-back feature that is tied to the lesser of A’s share
price on January 1, 20X2, or its share price on the purchase date. Because the grant date cannot be established
until all terms of the ESPP are determined (i.e., the purchase price is not determined until January 1, 20X2), the
grant date is January 1, 20X2.
Because the ESPP has multiple 6-month purchase periods, each with a look-back feature tied to A’s share price
at the beginning of the offering period (i.e., January 1, 20X2, or the grant date), the award in effect has a graded
vesting schedule. In addition, because each 6-month purchase period has the same grant date (i.e., January 1,
20X2), there are four separate tranches that have, respectively, a 6-month, 12-month, 18-month, and 24-month
requisite service period. Accordingly, A would recognize compensation cost on the basis of its established
policy for recognizing compensation cost for graded vesting awards with only a service condition. That is, A
would recognize compensation cost for this ESPP on either (1) an accelerated basis as though each portion of
the award for each separate requisite service period was, in substance, a separate award or (2) a straight-line
basis over all purchase periods from January 1, 20X2, through December 31, 20X3.
350
Example 8-4
Recognizing Compensation Cost for an ESPP With Multiple Look-Back Features Over Multiple
Purchase Periods
Assume the same facts as in Example 8-2, except that Entity A establishes a two-year offering period in which
its employees can purchase its shares on the following dates: June 30, 20X2; December 31, 20X2; June 30, 20X3;
and December 31, 20X3. For each six-month purchase period, the purchase price of A’s shares is based on
a look-back feature that is tied to the lesser of A’s share price at the beginning of each purchase period (i.e.,
January 1, 20X2; July 1, 20X2; January 1, 20X3; and July 1, 20X3) or its share price on each date of purchase.
Because the ESPP has multiple six-month purchase periods that have a look-back feature tied to A’s share price
at the beginning of each purchase period, each purchase period is, in effect, a separate award whose grant
date is at the beginning of each purchase period. Accordingly, A would measure and recognize compensation
cost separately and sequentially for each of the four six-month purchase periods.
Under the terms of some ESPPs, an employee may be entitled to purchase a specified dollar amount of
an entity’s stock on a future date at an established discount from the market price of the entity’s stock
on that future date (i.e., a variable number of shares for a fixed monetary amount). In addition, the
ESPP’s terms may not include a look-back feature. That is, the purchase price would not be the lower of
the purchase-date price or the enrollment-date price of the entity’s stock.
Provided that all other conditions for establishing a grant date have been met (see Section 3.2 for a
discussion of the conditions that must be met for a grant date to have occurred), the grant date would
be the date the employee purchases the shares (i.e., the purchase date), because the employee does
not begin to benefit from, or is not adversely affected by, subsequent changes in the employer’s stock
price until that date. The service inception date would be the enrollment date if the employee began
participating in the plan and is having money withheld to pay for the shares on that date.
Since the terms of the ESPP require the employee to purchase a specific dollar amount of the
employer’s stock on the purchase date, the amount of compensation cost is fixed and known on the
service inception date. That compensation cost is recognized over the requisite service period, which
is the period over which the employee participates in the plan and has money withheld to pay for the
shares on the purchase date.
In addition, because the employee is entitled to purchase a variable number of shares for a fixed
monetary amount, the award would be classified as a share-based liability (in accordance with ASC
718-10-25-7 and ASC 480) and recorded at its fair-value-based measure in each reporting period until
settlement (i.e., the purchase date).
351
Example 8-5
On January 1, 20X1, an employee enrolls in an ESPP. Under the plan, the employee elects to have an aggregate
amount of $850 withheld from pay over the next six months (i.e., until June 30, 20X1). The $850 will be used to
purchase a variable number of shares of the employer’s stock at a 15 percent discount from their market price
on June 30, 20X1. In accordance with ASC 718-50-25-3, the service inception date is January 1, 20X1, and the
grant date is June 30, 20X1. Accordingly, compensation cost of $150 — ($850 withheld from the employee’s
pay ÷ 85% discounted market price of the employer’s shares) – $850 withheld from the employee’s pay — is
recognized over the period from the service inception date (enrollment date or January 1, 20X1) to the grant
date (purchase date or June 30, 20X1). Because the plan’s terms specify that the employee purchases a variable
number of shares worth a fixed monetary amount, the amount of the benefit conveyed to the employee is
known on the service inception date (i.e., it is based on the discount from the market price of the entity’s shares
and the amount of cash the employee elects to withhold to purchase the entity’s shares) and is unaffected by
the number of the entity’s shares ultimately purchased.
Further, if on June 30, 20X1 (the purchase date), the entity’s stock is worth $2 per share, the employee would
purchase 500 of the entity’s shares — $850 withheld from the employee’s pay ÷ ($2 market price of the entity’s
shares × 85% discounted market price of the entity’s shares) — for $850, resulting in a discount of $150 from
the market value of the entity’s shares. Alternatively, if on June 30, 20X1, the entity’s shares are worth $4 per
share, the employee would purchase 250 of the entity’s shares — $850 withheld from the employee’s pay ÷
($4 market price of the entity’s shares × 85% discounted market price of the entity’s shares) — for $850, still
resulting in a discount of $150 from the market value of the entity’s shares.
In addition, because the award entitles the employee to purchase a variable number of the entity’s shares for a
fixed dollar amount, a share-based liability is recorded as the offsetting entry to compensation cost.
8.4 Forfeitures
ASC 718 allows an entity to make an entity-wide accounting policy election either to estimate forfeitures
when share-based payment awards are granted (and to update its estimate if information becomes
available indicating that actual forfeitures will differ from previous estimates) or to account for forfeitures
when they occur.
To comply with IRC Section 423, ESPPs typically have shorter requisite service periods than other share-
based payment awards (i.e., a six- or twelve-month purchase period is common). Nevertheless, an entity
must apply its entity-wide forfeiture accounting policy election to ESPPs. If an entity elects to estimate
forfeitures, it must do so when it recognizes compensation cost for ESPPs (and must update its estimate
if it receives new information indicating that actual forfeitures will differ from previous estimates).
When employee turnover is limited, an entity may conclude that it is appropriate to use a minimal
forfeiture estimate in determining compensation cost associated with an ESPP. See Section 3.4.1.1 for
a discussion of information that an entity may use in estimating forfeitures. See also the examples in
Sections 3.4.1.1 and 3.4.1.2 of how to account for forfeitures under either accounting policy election.
Note that when an employee elects to completely withdraw from an ESPP, the withdrawal should be
accounted for as a cancellation rather than as a forfeiture. Accordingly, any unrecognized compensation
cost should be recognized immediately for the canceled awards. See Section 8.6 for a discussion
of the accounting for increases and decreases in an employee’s withholdings (including a complete
withdrawal).
352
8.5 Measurement
ASC 718-50
General
30-1 Paragraph 718-10-30-6 states that the objective of the fair value measurement method is to estimate
the fair value of the equity instruments, based on the share price and other measurement assumptions at the
grant date, that are issued in exchange for providing goods or rendering services. Estimating the fair value of
equity instruments at the grant date, which are issued in exchange for employee services, also applies to the
fair value measurements associated with grants under a compensatory employee share purchase plan and is
the basis for the approach described in Example 1, Case A (see paragraph 718-50-55-10).
Look-Back Plans
30-2 Many employee share purchase plans with a look-back option have features in addition to or different
from those of the plan described in Example 1, Case A (see paragraph 718-50-55-10). For example, some plans
contain multiple purchase periods, others contain reset mechanisms, and still others allow changes in the
withholding amounts or percentages after the grant date (see Example 1, Cases B through E [see paragraphs
718-50-55-22 through 55-33]).
30-3 In some circumstances, applying the measurement approaches described in this Subtopic at the grant
date may not be practicable for certain types of employee share purchase plans. Paragraph 718-20-35-1
provides guidance on the measurement requirements if it is not possible to reasonably estimate fair value at
the grant date.
Under a compensatory ESPP, the measurement objective is the same as that described in ASC 718-10,
which is to estimate the fair-value-based measure of the equity instruments on the grant date. Chapter 4
of this Roadmap discusses the measurement objective outlined in ASC 718-10 in detail. In addition, see
Section 8.7 for examples of the measurement of plans with look-back features.
8.6 Changes in Employee Withholdings

ASC 718-50
General
35-1 Changes in total employee withholdings during a purchase period that occur solely as a result of salary
increases, commissions, or bonus payments are not plan modifications if they do not represent changes to
the terms of the award that was offered by the employer and initially agreed to by the employee at the grant
(or measurement) date. Under those circumstances, the only incremental compensation cost is that which
results from the additional shares that may be purchased with the additional amounts withheld (using the fair
value calculated at the grant date). For example, an employee may elect to participate in the plan on the grant
date by requesting that 5 percent of the employee’s annual salary be withheld for future purchases of stock.
If the employee receives an increase in salary during the term of the award, the base salary on which the 5
percent withholding amount is applied will increase, thus increasing the total amount withheld for future share
purchases. That increase in withholdings as a result of the salary increase is not considered a plan modification
and thus only increases the total compensation cost associated with the award by the grant date fair value
associated with the incremental number of shares that may be purchased with the additional withholdings
during the period. The incremental number of shares that may be purchased is calculated by dividing the
incremental amount withheld by the exercise price as of the grant date (for example, 85 percent of the grant
date stock price).
353
35-2 Any decreases in the withholding amounts (or percentages) shall be disregarded for purposes of
recognizing compensation cost unless the employee services that were valued at the grant date will no longer be
provided to the employer due to a termination. However, no compensation cost shall be recognized for awards
that an employee forfeits because of failure to satisfy a service requirement for vesting. The accounting for
decreases in withholdings is consistent with the requirement in paragraph 718-10-35-3 that the total amount of
compensation cost that must be recognized for an award 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).
8.6.1 Increase in Withholdings
The accounting for an increase in an employee’s withholding in connection with an ESPP depends on
whether the increase results from a rise in (1) the employee’s compensation (i.e., an increase in the
total dollar amount of the withholdings, but not the percentage) or (2) the percentage of the employee’s
compensation to be withheld.
In accordance with ASC 718-50-35-1, an increase in an employee’s withholding solely as a result of an

increase in an employee’s compensation (i.e., salary, commission, or bonus) is not accounted for as a
modification of the award (provided that no other changes to the terms of the ESPP have been made).
Incremental compensation cost results only from the additional shares that will be purchased with the
additional amounts withheld (under the fair-value-based measure calculated as of the grant date). In
other words, the increase in the withholding amount does not change the grant-date fair-value-based
measure per share of the award. Rather, it changes the quantity of shares that will be purchased in
connection with the total award.
By contrast, as indicated in ASC 718-50-55-29, an increase in the percentage of the employee’s

compensation to be withheld is accounted for as a modification of the award even though it is not
a change to the ESPP’s terms. Therefore, total recognized compensation cost attributable to the award
is (1) the grant-date fair-value-based measure of the original award for which the required service
has been provided (i.e., the number of awards that have been earned) or is expected to be provided
and (2) the incremental compensation cost conveyed to the holder of the award as a result of the
modification. The incremental compensation cost is the excess of the fair-value-based measure of the
modified award on the date of modification over the fair-value-based measure of the original award
immediately before the modification. See Section 8.7.4 for an example of how modification accounting
is applied in the determination of incremental compensation cost resulting from an increase in the
percentage of an employee’s withheld compensation.
8.6.2 Decrease in Withholdings
If, before the purchase date, an employee elects to irrevocably withdraw from an ESPP and receive a
complete refund of all amounts withheld from his or her pay, the withdrawal should be accounted for
as a cancellation if the employee continues employment with the entity. The employee has, in essence,
canceled the award associated with that offering. That is, the employee does not have the ability to
purchase the entity’s shares under the ESPP since the withdrawal is irrevocable. In accordance with ASC
718-20-35-9, a cancellation of an award that is not accompanied by the concurrent grant of (or offer
to grant) a replacement award or other valuable consideration is accounted for as a repurchase for no
consideration. Accordingly, any unrecognized compensation cost should be recognized immediately for
the canceled awards.
354
The period over which compensation cost is recognized is different for complete withdrawals than it is
for partial withdrawals. Under a partial withdrawal, employees decrease the amount of future payroll
withholdings during a purchase period. A decrease in the amount of future payroll withholdings will
result in the employee’s purchase of fewer of the entity’s shares on the purchase date. Since such
decreases are disregarded under ASC 718-50-35-2, compensation cost continues to be recognized over
the requisite service period on the basis of the entire grant-date fair-value-based measure of the award
unless the award is forfeited. Decreases in the amount of future payroll withholdings are the equivalent
of a failure of the employee to exercise a stock option that has been earned (i.e., vested). Compensation
cost can be reversed only when the employee forfeits the award (i.e., the employee fails to provide the
requisite service).
8.7 Look-Back Plans
The guidance in this section applies to common types of ESPPs that have look-back features. The
examples in the guidance illustrate how entities value ESPPs with look-back features and separate the
award into components to estimate the fair-value-based measure (see Sections 8.7.1 through 8.7.5).
For example, an ESPP that allows employees to purchase stock at a discount from the lesser of the
market price on the enrollment date or the purchase date would be valued as two components: (1) a
restricted stock award equal in value to the purchase discount and (2) an at-the-money stock option
equal to the discounted purchase price.
ASC 718-50
Variations on Basic Look-Back Plans

55-2 The following are some of the more common types of employee share purchase plans with a look-back
option that currently exist and the features that differentiate each type:
a. Type A plan — Maximum number of shares. This type of plan permits an employee to have withheld
a fixed amount of dollars from the employee’s salary (or a stated percentage of the employee’s salary)
over a one-year period to purchase stock. At the end of the one-year period, the employee may
purchase stock at 85 percent of the lower of the grant date stock price or the exercise date stock price.
If the exercise date stock price is lower than the grant date stock price, the employee may not purchase
additional shares (that is, the maximum number of shares that may be purchased by an employee
is established at the grant date based on the stock price at that date and the employee’s elected
withholdings); any excess cash is refunded to the employee. This is the basic type of employee share
purchase plan shown in Example 1, Case A [see paragraph 718-50-55-10]).
b. Type B plan — Variable number of shares. This type of plan is the same as the Type A plan except that
the employee may purchase as many shares as the full amount of the employee’s withholdings will
permit, regardless of whether the exercise date stock price is lower than the grant date stock price (see
Example 1, Case B [paragraph 718-50-55-22]).
c. Type C plan — Multiple purchase periods. This type of plan permits an employee to have withheld a
fixed amount of dollars from the employee’s salary (or a stated percentage of the employee’s salary)
over a two-year period to purchase stock. At the end of each six-month period, the employee may
purchase stock at 85 percent of the lower of the grant date stock price or the exercise date stock price
based on the amount of dollars withheld during that period (see Example 1, Case C [paragraph 718-50-
55-26]).
d. Type D plan — Multiple purchase periods with a reset mechanism. This type of plan is the same as the
Type C plan except that the plan contains a reset feature if the market price of the stock at the end of
any six-month purchase period is lower than the stock price at the original grant date. In that case, the
plan resets so that during the next purchase period an employee may purchase stock at 85 percent of
the lower of the stock price at either the beginning of the purchase period (rather than the original grant
date price) or the exercise date (see Example 1, Case D [paragraph 718-50-55-28]).
355
e. Type E plan — Multiple purchase periods with a rollover mechanism. This type of plan is the same as the
Type C plan except that the plan contains a rollover feature if the market price of the stock at the end of
any six-month purchase period is lower than the stock price at the original grant date. In that case, the
plan is immediately cancelled after that purchase date, and a new two-year plan is established using the
then-current stock price as the base purchase price (see Example 1, Case D [paragraph 718-50-55-28]).
f. Type F plan — Multiple purchase periods with semifixed withholdings. This type of plan is the same as
the Type C plan except that the amount (or percentage) that the employee may elect to have withheld
is not fixed and may be changed (increased or decreased) at the employee’s election immediately after
each six-month purchase date for purposes of all future withholdings under the plan (see Example 1,
Case D [paragraph 718-50-55-28]).
g. Type G plan — Single purchase period with variable withholdings. This type of plan permits an employee
to have withheld an amount of dollars from the employee’s salary (or a stated percentage of the
employee’s salary) over a one-year period to purchase stock. That amount (or percentage) is not fixed
and may be changed (increased or decreased) at the employee’s election at any time during the term of
the plan for purposes of all future withholdings under the plan. At the end of the one-year period, the
employee may purchase stock at 85 percent of the lower of the grant date stock price or the exercise
date stock price (see Example 1, Case D [paragraph 718-50-55-28]).
h. Type H plan — Multiple purchase periods with variable withholdings. This type of plan combines the
characteristics of the Type C and Type G plans in that there are multiple purchase periods over the term
of the plan and an employee is permitted to change (increase or decrease) withholding amounts (or
percentages) at any time during the term of the plan for purposes of all future withholdings under the
plan (see Example 1, Case D [paragraph 718-50-55-28]).
i. Type I plan — Single purchase period with variable withholdings and cash infusions. This type of plan
is the same as the Type G plan except that an employee is permitted to remit catch-up amounts to the
entity when (and if) the employee increases withholding amounts (or percentages). The objective of the
cash infusion feature is to permit an employee to increase withholding amounts (or percentages) during
the term of the plan and remit an amount to the entity such that, on the exercise date, it appears that
the employee had participated at the new higher amount (or percentage) during the entire term of the
plan (see Example 1, Case E [paragraph 718-50-55-32]).
55-3 The distinguishing characteristic between the Type A plan and the Type B plan is whether the maximum
number of shares that an employee is permitted to purchase is fixed at the grant date based on the stock price
at that date and the expected withholdings. Each of the remaining plans described above (Type C through Type
I plans) incorporates the features of either a Type A plan or a Type B plan. The above descriptions are intended
to be representative of the types of features commonly found in many existing plans. The accounting guidance
in this Subtopic shall be applied to all plans with characteristics similar to those described above.
55-4 The measurement approach described in Example 1, Case A (see paragraph 718-50-55-10) was developed
to illustrate how the fair value of an award under a basic type of employee share purchase plan with a
look-back option could be determined at the grant date by focusing on the substance of the arrangement
and valuing separately each feature of the award. Although that general technique of valuing an award as the
sum of the values of its separate components applies to all types of employee share purchase plans with a
look-back option, the fundamental components of an award may differ from plan to plan thus affecting the
individual calculations. For example, the measurement approach described in that Case assumes that the
maximum number of shares that an employee may purchase is fixed at the grant date based on the grant date
stock price and the employee’s elected withholdings (that is, the Type A plan described in paragraph 718-50-
55-2). That approach needs to be modified to appropriately determine the fair value of awards under the other
types of plans described in that paragraph, including a Type B plan, that do not fix the number of shares that
an employee is permitted to purchase.
356
55-5 Although many employee share purchase plans with a look-back option initially limit the maximum
number of shares of stock that the employee is permitted to purchase under the plan (Type A plans), other
employee share purchase plans (Type B plans) do not fix the number of shares that the employee is permitted
to purchase if the exercise date stock price is lower than the grant date stock price. In effect, an employee
share purchase plan that does not fix the number of shares that may be purchased has guaranteed that
the employee can always receive the value associated with at least 15 percent of the stock price at the grant
date (the employee can receive much more than 15 percent of the grant date value of the stock if the stock
appreciates during the look-back period). That provision provides the employee with the equivalent of a put
option on 15 percent of the shares with an exercise price equal to the stock price at the grant date. In contrast,
an employee who participates in a Type A plan is only guaranteed 15 percent of the lower of the stock price as
of the grant date or the exercise date, which is the equivalent of a call option on 85 percent of the shares (as
described more fully in paragraph 718-50-55-16). A participant in a Type B plan receives the equivalent of both
a put option and a call option.
Illustrations
Example 1: Look-Back Plans
55-6 The following Cases illustrate the guidance in paragraphs 718-50-30-1 through 30-2.
55-7 The following Cases illustrate the fundamental differences between different types of look back plans:
a. Basic look-back plans (Case A)
b. Look-back plan variable versus maximum number of shares (Case B)
c. Look-back plan with multiple purchase periods (Case C)
d. Look-back plans with reset or rollover mechanisms (Case D)
e. Look-back plans with retroactive cash infusion election (Case E).
55-8 The assumptions used for the numerical calculations in Cases B–E are not intended to be the same as
those in Case A. Rather, they are independent and designed to illustrate how the component measurement
approach in Case A would be modified to reflect various features of employee stock purchase plans.
55-9 This Example does not take into consideration the effect of interest forgone by the employee on the fair
value of an award for which the exercise price is paid over time (for instance, through payroll withholdings).
Awards for which part or all of the exercise price is paid before the exercise date are less valuable than awards
for which the exercise price is paid at the exercise date, and it is appropriate to recognize that difference in
applying the guidance in this Subtopic. However, for simplicity, the effect of forgone interest is not reflected in
the fair value calculations in this Example.
8.7.1 Basic Look-Back Plans

ASC 718-50
Case A: Basic Look-Back Plans

55-10 Some entities offer share options to employees under Section 423 of the U.S. Internal Revenue Code,
which provides that employees will not be immediately taxed on the difference between the market price of the
stock and a discounted purchase price if several requirements are met. One requirement is that the exercise
price may not be less than the smaller of either:
a. 85 percent of the stock’s market price when the share option is granted
b. 85 percent of the price at exercise.
357
55-11 A share option that provides the employee the choice of either option above may not have a term in
excess of 27 months. Share options that provide for the more favorable of two (or more) exercise prices are
referred to as look-back share options. A look-back share option with a 15 percent discount from the market
price at either grant or exercise is worth more than a fixed share option to purchase stock at 85 percent of the
current market price because the holder of the look-back share option is assured a benefit. If the share price
rises, the holder benefits to the same extent as if the exercise price was fixed at the grant date. If the share
price falls, the holder still receives the benefit of purchasing the stock at a 15 percent discount from its price at
the date of exercise. An employee share purchase plan offering share options with a look-back feature would
be compensatory because the look-back feature is an option feature (see paragraph 718-50-25-1).
55-12 For example, on January 1, 20X5, when its share price is $30, Entity A offers its employees the
opportunity to sign up for a payroll deduction to purchase its stock at either 85 percent of the share’s current
price or 85 percent of the price at the end of the year when the share options expire, whichever is lower. The
exercise price of the share options is the lesser of $25.50 ($30 × .85) or 85 percent of the share price at the
end of the year when the share options expire.
55-13 The look-back share option can be valued as a combination position. (This Case presents one of several
existing valuation techniques for estimating the fair value of a look-back option. In accordance with this Topic,
an entity shall use a valuation technique that reflects the substantive characteristics of the instrument being
granted in the estimate of fair value.) In this situation, the components are as follows:
a. 0.15 of a share of nonvested stock
b. 0.85 of a 1-year share option held with an exercise price of $30.
55-14 Supporting analysis for the two components is discussed below.
55-15 Beginning with the first component, a share option with an exercise price that equals 85 percent of the
value of the stock at the exercise date will always be worth 15 percent (100% – 85%) of the share price upon
exercise. For a stock that pays no dividends, that share option is the equivalent of 15 percent of a share of
the stock. The holder of the look-back share option will receive at least the equivalent of 0.15 of a share of
stock upon exercise, regardless of the share price at that date. For example, if the share price falls to $20, the
exercise price of the share option will be $17 ($20 × .85), and the holder will benefit by $3 ($20 – $17), which is
the same as receiving 0.15 of a share of stock for each share option.
55-16 If the share price upon exercise is more than $30, the holder of the look-back share option receives a
benefit that is worth more than 15 percent of a share of stock. At prices of $30 or more, the holder receives a
benefit for the difference between the share price upon exercise and $25.50 — the exercise price of the share
option (.85 × $30). If the share price is $40, the holder benefits by $14.50 ($40 – $25.50). However, the holder
cannot receive both the $14.50 value of a share option with an exercise price of $25.50 and 0.15 of a share of
stock. In effect, the holder gives up 0.15 of a share of stock worth $4.50 ($30 × .15) if the share price is above
$30 at exercise. The result is the same as if the exercise price of the share option was $30 ($25.50 + $4.50) and
the holder of the look-back share option held 85 percent of a 1-year share option with an exercise price of $30
in addition to 0.15 of a share of stock that will be received if the share price is $30 or less upon exercise.
55-17 An option-pricing model can be used to value the 1-year share option on 0.85 of a share of stock
represented by the second component. Thus, assuming that the fair value of a share option on one share of
Entity A’s stock on the grant date is $4, the compensation cost for the look-back option at the grant date is as
follows.
0.15 of a share of nonvested stock ($30 × 0.15) $ 4.50
Share option on 0.85 of a share of stock, exercise price of $30 ($4 × .85) 3.40
Total grant date value $ 7.90
358
55-18 For a look-back option on a dividend-paying share, both the value of the nonvested stock component
and the value of the share option component would be adjusted to reflect the effect of the dividends that the
employee does not receive during the life of the share option. The present value of the dividends expected
to be paid on the stock during the life of the share option (one year in this Case) would be deducted from the
value of a share that receives dividends. One way to accomplish that is to base the value calculation on shares
of stock rather than dollars by assuming that the dividends are reinvested in the stock.
55-19 For example, if Entity A pays a quarterly dividend of 0.625 percent (2.5% ÷ 4) of the current share price,
1 share of stock would grow to 1.0252 (the future value of 1 using a return of 0.625 percent for 4 periods)
shares at the end of the year if all dividends are reinvested. Therefore, the present value of 1 share of stock to
be received in 1 year is only 0.9754 of a share today (again applying conventional compound interest formulas
compounded quarterly) if the holder does not receive the dividends paid during the year.
55-20 The value of the share option component is easier to compute; the appropriate dividend assumption
is used in an option-pricing model in estimating the value of a share option on a whole share of stock. Thus,
assuming the fair value of the share option is $3.60, the compensation cost for the look-back share option if
Entity A pays quarterly dividends at the annual rate of 2.5 percent is as follows.
0.15 of a share of nonvested stock ($30 × 0.15 × 0.9754) $ 4.39
Share option on 0.85 of a share of stock, $30 exercise price, 3.06

2.5% dividend yield ($3.60 × .85)
Total grant date value $ 7.45
55-21 The first component, which is worth $4.39 at the grant date, is the minimum amount of benefits to the
holder regardless of the price of the stock at the exercise date. The second component, worth $3.06 at the
grant date, represents the additional benefit to the holder if the share price is above $30 at the exercise date.
359
8.7.2 Variable Versus Maximum Number of Shares

ASC 718-50
Case B: Look-Back Plan Variable Versus Maximum Number of Shares

55-22 On January 1, 20X0, when its stock price is $50, Entity A offers its employees the opportunity to sign up
for a payroll deduction to purchase its stock at the lower of either 85 percent of the stock’s current price or
85 percent of the stock price at the end of the year when the options expire. Thus, the exercise price of the
options is the lesser of $42.50 ($50 × 85 percent) or 85 percent of the stock price at the end of the year when
the option is exercised. Two employees each agree to have $4,250 withheld from their salaries; however,
Employee A is not allowed to purchase any more shares than the $4,250 would buy on the grant date (that
is, 100 shares [$4,250/$42.50]) and Employee B is permitted to buy as many shares as the $4,250 will permit
under the terms of the plan. In both cases, the 15 percent purchase price discount at the grant date is worth
$750 (100 shares × $50 × 15 percent). Depending on the stock price at the end of the year, the value of the 15
percent discount for each employee is as follows.
Stock Price at the Number of Value of the 15

End of the Year Shares Purchased Percent Discount
Scenario 1:(a)
Employee A (Type A plan) $ 60 100 $ 1,750
Employee B (Type B plan) $ 60 100 $ 1,750
Scenario 2: (b)
Employee A (Type A plan) $ 50 100 $ 750
Employee B (Type B plan) $ 50 100 $ 750
Scenario 3:(c)
Scenario 4:(d)

(a) The purchase price in this scenario would be $42.50 ($50 × 0.85) because the stock price increased
during the withholding period.
(b) The purchase price in this scenario would be $42.50 ($50 × 0.85) because the stock price at the end
of the period was the same as the stock price at the beginning of the period.
(c) The purchase price in this scenario would be $25.50 ($30 × 0.85) because the stock price decreased
(d) The purchase price in this scenario would be $8.50 ($10 × 0.85) because the stock price decreased
360
55-23 As illustrated above, both awards provide the same value to the employee if the stock price at the
exercise date has increased (or remained unchanged) from the grant date stock price. However, the award
under the Type B plan is more valuable to the employee if the stock price at the exercise date has decreased
from the grant date stock price because it guarantees that the employee always will receive at least 15 percent
of the stock price at the grant date, whereas the award under the Type A plan only guarantees that the
employee will receive 15 percent of the ultimate (lower) stock purchase price.
55-24 Using the component measurement approach described in Case A as the base, the additional feature
associated with a Type B plan that shall be included in the fair value calculation is 15 percent of a put option
on the employer’s stock (valued by use of a standard option-pricing model, using the same measurement
assumptions that were used to value the 85 percent of a call option). If the plan in that Case had the provisions
of a Type B plan (that is, a plan that does not fix the number of shares that may be purchased), the fair value of
the award would be calculated at the grant date as follows.
One-year call on 0.85 of a share of stock, exercise price of $50 ($7.56 × 0.85) 6.43
One-year put on 0.15 of a share of stock, exercise price of $50 ($4.27 × .15)(a) 0.64
Total grant date fair value $ 14.57

(a) Other assumptions are the same as those used to value the call option; $50 stock price, an expected life
of one year, expected volatility of 30 percent, risk-free interest rate of 6.8 percent, and a zero dividend
yield.
With the same values the fair value of the Type A employee share purchase plan award described in Case A is
determined as follows:
Total grant date fair value $ 13.93
55-25 In Cases B through E, total compensation cost would be measured at the grant date based on the
number of shares that can be purchased using the estimated total withholdings and market price of the
stock as of the grant date, and not based on the potentially greater number of shares that may ultimately be
purchased if the market price declines. In other words, assume that on January 1, 20X0, Employee A elects to
have $850 withheld from his pay for the year to purchase stock. Total compensation cost for the Type B plan
award to Employee A would be $291 ($14.57 × 20 grant-date-based shares [$850/$42.50]). For purposes of
determining the number of shares on which to measure compensation cost, the stock price as of the grant
date less the discount, or $50 × 85 percent in this case, is used.
361
8.7.3 Multiple Purchase Periods

ASC 718-50
Case C: Look-Back Plan With Multiple Purchase Periods

55-26 In substance, an employee share purchase plan with multiple purchase periods (a Type C plan) is a series
of linked awards, similar in nature to how some view a graded vesting stock option plan. Accordingly, the fair
value of an award under an employee share purchase plan with multiple purchase periods shall be determined
at the grant date in the same manner as an award under a graded vesting stock option plan. Under the graded
vesting approach, awards under a two-year plan with purchase periods at the end of each year would be valued
as having two separate option tranches both starting on the initial grant date (using the Case A approach if the
plan has the characteristics of a Type A plan or using the Case B approach if the plan has the characteristics of
a Type B plan) but with different lives of 12 and 24 months, respectively. All other measurement assumptions
would need to be consistent with the separate lives of each tranche.
55-27 For example, if the plan in Case A was a two-year Type C plan with purchase periods at the end of each
year, the fair value of each tranche of the award would be calculated at the grant date as follows.
Tranche No. 1:
One-year call on 0.85 of a share of stock, exercise price of $50 ($7.56 × 0.85)(a) 6.43
Total grant date fair value of the first tranche $ 13.93
Tranche No. 2:
Two-year call on 0.85 of a share of stock, exercise price of $50 ($11.44 × 0.85) (a)
9.72
Total grant date fair value of the second tranche $ 17.22

(a) The other assumptions are $50 stock price, an expected life of 1 year, expected volatility of 30 percent,
risk-free interest rate of 6.8 percent, and a zero dividend yield (same assumptions as in footnote [a] of
the table in paragraph 718-50-55-24). To simplify the illustration, the fair value of each of the tranches is
based on the same assumptions about volatility, the risk-free interest rate, and expected dividend yield.
In practice, each of those assumptions would be related to the expected life of the respective tranche,
which means that at least the risk-free interest rate, and perhaps all three assumptions, would differ for
each tranche.
8.7.4 Reset or Rollover Mechanisms

ASC 718-50
Case D: Look-Back Plans With Reset or Rollover Mechanisms

55-28 The basic measurement approach described in Case C for a Type C plan also should be used to value
awards under employee share purchase plans with multiple purchase periods that incorporate reset or rollover
mechanisms (that is, Type D and Type E plans). The fair value of those awards initially can be determined at the
grant date using the graded vesting measurement approach. However, at the date that the reset or rollover
mechanism becomes effective, the terms of the award have been modified (the exercise price has been
decreased and, for a grant under a Type E plan, the term of the award has been extended), which, in substance,
is similar to an exchange of the original award for a new award with different terms. Share-based payment
modification accounting (see paragraphs 718-20-35-3 through 35-9) shall be applied at the date that the reset
or rollover mechanism becomes effective to determine the amount of any incremental fair value associated
with the modified grant.
362
55-29 Likewise, although not a change to the terms of the employee share purchase plan, an election by an
employee to increase withholding amounts (or percentages) for future services (Type F through Type H plans) is
a modification of the terms of the award to that employee, which, in substance, is similar to an exchange of the
original award for a new award with different terms. Accordingly, the fair value of an award under an employee
share purchase plan with variable withholdings shall be determined at the grant date (using the Type A, Type
B, or Type C measurement approach, as applicable) based on the estimated amounts (or percentages) that a
participating employee initially elects to withhold under the terms of the plan. After the grant date (except as
noted in paragraph 718-50-35-1), any increases in withholding amounts (or percentages) for future services
shall be accounted for as a plan modification in accordance with the guidance in paragraph 718-20-35-3.
55-30 To illustrate, if the plan described in Case C allowed an employee to elect to change withholdings at the
end of the first year, modification accounting would be applied at the date the employee elected to increase
withholdings to determine the amount, if any, of incremental compensation cost. Assume that on January
1, 20X0, Employee A initially elected to have $850 per year withheld from his pay for each purchase period.
However, at the end of Year 1 when the stock price is $60 (and assume that no other factors have changed),
Employee A elects to have a total of $1,275 withheld for the second purchase period. At that date, $1,275
is equivalent to 30 shares eligible for purchase at the end of the second year ($1,275/$42.50). At the date
Employee A elects to increase withholdings, modification accounting shall be applied to determine the amount
of any incremental fair value associated with the modified award as follows.
Fair value of the old option (Tranche No. 2) before modification:
Total fair value of each option $ 21.84
Number of grant date shares ($850 ÷ $42.50) × 20
Total fair value $ 437.00
Fair value of the new option after modification:
Total fair value of each option $ 21.84
Number of modification date shares ($1,275 ÷ $42.50) × 30
Total fair value $ 655
Incremental compensation $ 218
55-31 The incremental value is determined based on the fair value measurements at the date of the
modification using the then-current stock price. To simplify the illustration, the fair value at the modification
date is based on the same assumptions about volatility, the risk-free interest rate, and expected dividend yield
as at the grant date.
363
8.7.5 Retroactive Cash Infusion Election

ASC 718-50
Case E: Look-Back Plans With Retroactive Cash Infusion Election

55-32 As with all employee share purchase plans, the objective of the measurement process for employee
share purchase plans with a look-back option is to reasonably measure the fair value of the award at the grant
date. Unlike Type F through Type H plans, which permit an employee to increase withholding amounts (or
percentages) only prospectively, the Type I plan permits an employee to make a retroactive election to increase
withholdings. Under a Type I plan, an employee may elect not to participate (or to participate at a minimal level)
in the plan until just before the exercise date, thus making it difficult to determine when there truly is a mutual
understanding of the terms of the award, and thus the date at which the grant occurs. For example, assume
that the Type A employee share purchase plan in Case A permits an employee to remit catch-up amounts (up
to a maximum aggregate withholding of 15 percent of annual salary) to Entity A at any time during the term of
the plan. On January 1, 20X0, Employee A elects to participate in the plan by having $100 (0.04 percent) of her
$250,000 salary withheld monthly from her pay over the year. On December 20, 20X0, when the stock price is
$65, Employee A elects to remit a check to Entity A for $36,300, which, together with the $1,200 withheld during
the year, represents 15 percent of her salary.
55-33 In that situation, December 20, 20X0 is the date at which Entity A and Employee A have a mutual
understanding of the terms of the award in exchange for the services already rendered and Entity A becomes
contingently obligated to issue equity instruments to Employee A upon the fulfillment of vesting requirements.
The fair value of the entire award to Employee A is therefore measured as of December 20, 20X0.
364
Chapter 9 — Nonemployee Awards
9.1 Overview
ASC 718-10
General
05-1 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. Employee Stock Ownership Plans
e. Employee Stock Purchase Plans
f. Income Taxes.
05-2 This Topic provides guidance for employee and nonemployee share-based payment transactions.
05-3 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.
General
10-1 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.
ownership plans.
365
The objectives of accounting for share-based payment arrangements are the same for nonemployees
as they are for employees, and therefore the guidance on nonemployee and employee awards is largely
aligned. However, there are some significant differences, two of which are as follows:
• Attribution — Any cost associated with nonemployee awards is recognized under other
applicable accounting guidance as though the grantor paid cash. That is, ASC 718 does not
prescribe the period(s) or the manner (i.e., capitalize or expense) in which nonemployee share-
based payments will be recognized. Rather, an entity should recognize an asset or expense
(or reverse a previously recognized cost) in the same period(s) and in the same manner as
though the entity had paid cash for the goods or services. By contrast, any compensation cost
associated with employee awards is generally recognized on a ratable basis over the requisite
service period (or over multiple requisite service periods).
• Contractual term — Nonemployee awards of stock options and similar instruments are measured
by using the expected term, but the contractual term may be elected as the expected term
on an award-by-award basis. By contrast, all employee awards of stock options and similar
instruments are measured by using an estimate of the expected term.
9.2 Scope
ASC 718-10
Entities
15-2 The guidance in the Compensation — Stock Compensation Topic applies to all entities that enter into
Transactions
instruments.
15-3A Paragraphs 323-10-25-3 through 25-5 provide guidance on accounting for share-based compensation
services to the investee that are used or consumed in the investee’s operations.
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.
366
15-5 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 815-40-35-14 through
35-15, 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.
606-10-32-26.
ASC 718 applies to all share-based payment arrangements related to the acquisition of goods and
services from employees and nonemployees. Therefore, most of the guidance in ASC 718 on employee
share-based payments, including most of its requirements related to classification and measurement,
applies to nonemployee share-based payment arrangements. However, it is still important to determine
whether the counterparty (i.e., the grantee) is an employee or a nonemployee since there are certain
differences in the respective guidance (see Section 9.1).
Entities are required to apply ASC 718 to measure and classify share-based payments issued as
consideration payable to a customer under ASC 606. However, ASC 606 addresses the recognition of
share-based sales incentives (e.g., as a reduction of revenue). For information about accounting for
share-based payments issued as sales incentives, see Section 9.2.1 and Chapter 14.
ASC 718 does not address the accounting for share-based payments received by a grantee. Such
payments are subject to ASC 606, which addresses share-based payments received by a vendor in a
contract with a customer. Under ASC 606, share-based payments (i.e., noncash consideration) received
by a vendor (grantee) from a customer (grantor) are measured at their fair value at contract inception.
For more information, see Chapter 6 of Deloitte’s Roadmap Revenue Recognition.
ASC 718 also does not apply to equity instruments issued to a lender or investor that provides financing
to the issuer. In paragraph BC21 of ASU 2018-07, the FASB clarified that ASC 718 applies to “instruments
granted for goods or services used or consumed in a grantor’s own operations and does not apply to
instruments granted essentially to provide financing to the issuer.” The Board included this anti-abuse
measure to prevent entities from structuring a share-based payment transaction as a means of raising
capital and accounting for it under ASC 718 (particularly its classification guidance).
367
9.2.1 Sales Incentives to Customers

ASC 718-10
15-5A 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.
ASC 606-10
32-25 Consideration payable to a customer includes:

a. Cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase
the entity’s goods or services from the customer)
b. Credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to
the entity (or to other parties that purchase the entity’s goods or services from the customer)
c. Equity instruments (liability or equity classified) granted in conjunction with selling goods or services (for
example, shares, share options, or other equity instruments).
An entity shall account for consideration payable to a customer as a reduction of the transaction price and,
therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service
(as described in paragraphs 606-10-25-18 through 25-22) that the customer transfers to the entity. If the
consideration payable to a customer includes a variable amount, an entity shall estimate the transaction
price (including assessing whether the estimate of variable consideration is constrained) in accordance with
paragraphs 606-10-32-5 through 32-13.
ASC 718 applies to the measurement and classification of share-based payment awards issued as
consideration payable to a customer. If such consideration is not in exchange for a distinct good or
service, ASC 606 requires that the consideration be reflected as a reduction of the transaction price.
However, ASC 606-10-32-26 states, in part, that “[i]f consideration payable to a customer is a payment
for a distinct good or service from the customer, then an entity shall account for the purchase of the
good or service in the same way that it accounts for other purchases from suppliers.”
9.3 Recognition
ASC 718-10
Recognition Principle for Share-Based Payment Transactions

25-2 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 718-10-25-2A
through 25-2B. 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).
25-2B 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.
368
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.
35-1A 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.
35-1B 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.
35-1C 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.
35-1E A recognized asset or expense shall not be reversed if a stock option that the nonemployee has the right
to exercise expires unexercised.
35-1F 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.
As in the case of a share-based payment arrangement with an employee, a share-based payment

arrangement with a nonemployee is an exchange between the issuing entity and the grantee providing
the goods or services. An entity typically recognizes the effect of that exchange in the balance sheet and
income statement as the goods or services are received. The entity may either (1) recognize the cost as
an expense as the goods or services are received or (2) capitalize the cost as part of an asset and later
recognize it as an expense. For example, if the cost associated with an award is included in the cost
369
of acquiring or producing inventory, the cost arising from the award is capitalized, and the capitalized
cost is later recognized as cost of goods sold. As discussed in Section 9.1, any cost associated with
nonemployee awards is recognized under other applicable accounting guidance as though the grantor
paid cash. The term “nonemployee’s vesting period” as used throughout ASC 718 and this publication
is intended to represent the recognition of compensation cost for a nonemployee award 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 the share-based payment award.
The credit in the balance sheet is based on the award’s classification. If the award is classified as
equity, the corresponding credit is recorded in equity — typically as paid-in capital. The measurement
date for equity-classified awards is generally the grant date (see Section 3.2 for further discussion of
the determination of the grant date). If an award is classified as a liability, the corresponding credit
is recorded as a share-based liability. Liability-classified awards are remeasured as of each reporting
date until settlement. See Section 9.5 and Chapter 5 for discussions of the classification of awards and
Chapter 7 for a discussion of the accounting for liability-classified awards.
Example 9-1
On January 1, 20X1, Entity A enters into an arrangement with an advertising company that provides marketing
services for the next two years in exchange for 1,000 equity-classified warrants. The warrants vest at the end of
two years (i.e., when the marketing services are complete). Assume that the grant date is January 1, 20X1, and
the marketing services are provided ratably over the two-year period.
The fair-value-based measure of the warrants on January 1, 20X1, is $10. The following journal entries illustrate
the recognition under ASC 718:
December 31, 20X1
Marketing expense 5,000

APIC 5,000
To record marketing expense on the basis of the grant-date
fair-value-based measure (1,000 warrants × $10 fair-value-based
measure × 50% for 1 of 2 years of services rendered).
December 31, 20X2

APIC 5,000
To record marketing expense on the basis of the grant-date
fair-value-based measure [(1,000 warrants × $10 fair-value-
based measure × 100% of services rendered) – $5,000
marketing expense previously recognized].
370
9.3.1 Attribution of Cost
9.3.1.1 Recognition as if Cash Were Paid
For share-based payment arrangements with employees, compensation cost is generally recognized
ratably over the requisite service period (or ratably over multiple requisite service periods; see Section
3.6). Because of the nature of nonemployee awards, ratable recognition over a service period may not
necessarily be appropriate. Any cost recognized for nonemployee share-based payments should be
recognized under other applicable accounting guidance as though the grantor paid cash. That is, ASC
718 does not prescribe the period(s) or the manner (i.e., capitalize or expense) in which nonemployee
share-based payments will be recognized. Rather, an entity should recognize an asset or expense (or
reverse a previously recognized cost) in the same period(s) and in the same manner as though the entity
had paid cash for the goods or services. Accordingly, an entity recognizes the cost of nonemployee
awards during the nonemployee’s vesting period “when it obtains the goods or as services are received.”
An entity must use judgment in determining the attribution of costs since they may not be tied directly
to nonemployee vesting conditions. The entity could grant awards to a vendor that provides services
ratably but for which vesting is tied solely to the level of performance. For instance, a vendor could
provide services associated with a call center ratably over time, but vesting of the awards could be tied
to the resolution of issues within a certain period. Similarly, awards could be provided to a nonemployee
for goods, but vesting may not be tied to the delivery of goods (e.g., a nonemployee award issued for
goods may vest if less than 1 percent of all goods delivered over a specified period are defective).
9.3.1.2 Graded Vesting Awards

As discussed in Section 3.6.5, an entity is required to elect, as its accounting policy, one of the following
methods to recognize compensation cost on a straight-line basis over the requisite service period
for employee awards that have graded vesting schedules and only contain service conditions (i.e., no
performance or market conditions):
• Each separately vesting portion of the award as if the award was, in substance, multiple awards.
• The entire award (i.e., over the requisite service period of the last separately vesting portion of
the award).
The policy election is limited to employee awards. Other than as described in Section 9.3, ASC 718 does
not provide explicit guidance on the period(s) or manner of cost recognition for nonemployee awards
and consequently does not include a similar policy election for graded vesting nonemployee awards.
9.3.2 Vesting Conditions
Vest
To earn the rights to. A share-based payment award becomes vested at the date that the grantee’s right to
receive or retain shares, other instruments, or cash under the award is no longer contingent on satisfaction of
either a service condition or a performance condition. Market conditions are not vesting conditions.
The stated vesting provisions of an award often establish the employee’s requisite service period or the
nonemployee’s vesting period, and an award that has reached the end of the applicable period is vested.
However, as indicated in the definition of requisite service period and equally applicable to a nonemployee’s
vesting period, the stated vesting period may differ from those periods in certain circumstances. Thus, the
more precise terms would be options, shares, or awards for which the requisite good has been delivered
or service has been rendered and the end of the employee’s requisite service period or the nonemployee’s
vesting period.
371
While most nonemployee awards are issued in exchange for services, there may be instances in which
such awards are issued for goods. Accordingly, the definition of “vest” in ASC 718 incorporates vesting
conditions tied to the delivery of goods (in addition to services) and uses the term “nonemployee’s
vesting period” rather than “requisite service period” to describe the period during which the cost
associated with nonemployee awards is recognized (i.e., as the goods or services are provided).
Under ASC 718, service and performance conditions are vesting conditions, while market conditions are
incorporated into the fair-value-based measurement of share-based payments.
9.3.2.1 Service Condition
Service Condition
the fair value of an award that depends solely on an employee rendering service to the employer for the
requisite service period or a nonemployee delivering goods or rendering services to the grantor over a vesting
period. A condition that results in the acceleration of vesting in the event of a grantee’s death, disability, or
termination without cause is a service condition.
The definition of service condition incorporates characteristics of nonemployee awards by stating that
such a condition can be satisfied if “a nonemployee deliver[s] goods or render[s] services to the grantor
over a vesting period.”
ASC 718-10
35-1D 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.
In a manner similar to employee awards as discussed in Section 3.4, ASC 718 allows an entity to make
an entity-wide policy election for all nonemployee awards (including share-based payments issued as
sales incentives to customers) to either (1) estimate forfeitures or (2) recognize forfeitures when they
occur. The policy election is independent of the entity’s policy election for employee awards. If the entity
elects to estimate forfeitures, it should recognize the cost of nonemployee awards on the basis of its
estimate of awards for which the goods are expected to be delivered or the service is expected to be
rendered, and the entity should revise its estimate as appropriate.
372
An entity’s forfeiture policy is associated solely with service conditions. The entity must assess the
probability of achieving any performance conditions and may not make a policy election for performance
conditions. However, as noted above, unlike employee service conditions, nonemployee vesting
conditions might not be tied to the provision of service for a specific period. An entity will need to use
judgment to determine whether its forfeiture policy applies to certain nonemployee vesting conditions,
because it may not be obvious whether such conditions are service or performance conditions. See
Section 9.3.2.2 for a discussion of determining whether a nonemployee vesting condition is a service
condition or performance condition.
In addition, an entity may consider the nature and volume of awards granted to nonemployees when
assessing which forfeiture accounting policy to elect. The number of nonemployee award grantees may
not be significant relative to that of employee award grantees (which often consist of large employee
pools). Consequently, there may be insufficient historical forfeiture data, which may make it difficult for
an entity to estimate how many nonemployee awards will be forfeited. In such circumstances, an entity
that elects to estimate forfeitures might conclude that each nonemployee will fulfill its contract and that
no awards are estimated to be forfeited. However, an entity may reasonably estimate forfeitures on the
basis of historical forfeiture data if the volume of nonemployee providers is large and the nonemployees
share similar characteristics. For example, an entity may grant awards to employees of a third-party
management advisory company that vest if the grantees provide advisory services for a specified period.
In this situation, the entity may be able to use historical forfeiture data to estimate forfeitures if the
grantees perform a function that is similar to that of the entity’s employees.
9.3.2.2 Performance Condition
Performance Condition
the fair value of an award that relates to both of the following:
a. Rendering service or delivering goods for a specified (either explicitly or implicitly) period of time
b. Achieving a specified performance target that is defined solely by reference to the grantor’s own
operations (or activities) or by reference to the grantee’s performance related to the grantor’s own
operations (or activities).
Attaining a specified growth rate in return on assets, obtaining regulatory approval to market a specified
product, selling shares in an initial public offering or other financing event, and a change in control are
examples of performance conditions. A performance target also may be defined by reference to the same
performance measure of another entity or group of entities. For example, attaining a growth rate in earnings
per share (EPS) that exceeds the average growth rate in EPS of other entities in the same industry is a
performance condition. A performance target might pertain to the performance of the entity as a whole or
to some part of the entity, such as a division, or to the performance of the grantee if such performance is in
accordance with the terms of the award and solely relates to the grantor’s own operations (or activities).
The definition of performance condition incorporates characteristics of nonemployee awards since

it states that the performance target might pertain to the “performance of the grantee if such
performance is in accordance with the terms of the award and solely relates to the grantor’s own
operations (or activities).” An entity is required to recognize any cost on the basis of the probable
outcome of performance conditions.
373
Example 9-2
On January 1, 20X1, Entity C enters into a contract with an advertising company that provides marketing
services in exchange for a cash fee. The marketing services are completed on December 31, 20X1. The cost
associated with the cash fee is recognized as the marketing services are performed. In addition, if C achieves
$100 million in sales over a one-year period after the services are provided (January 1, 20X2, through December
31, 20X2), the advertising company will receive 100 equity-classified warrants. Entity C concludes that it is
probable that it will achieve $100 million in sales for the one-year period, and it achieves that sales target on
December 31, 20X2.
Under ASC 718, C recognizes the grant-date fair-value-based measure of the warrants since achievement of
the sales target is probable. In addition, C would generally recognize the cost as the marketing services are
performed.
The fair-value-based measure of the warrants on January 1, 20X1, is $10. The following journal entries illustrate
the recognition under ASC 718:
December 31, 20X1

APIC 1,000
To record marketing expense on the basis of the grant-date fair-
value-based measure since it is probable that the performance
condition will be achieved (100 warrants × $10 fair-value-based
measure).
Because the vesting conditions of nonemployee awards might not be similar to those of employee
awards (e.g., employment for a specified period), an entity must apply judgment in determining whether
a nonemployee vesting condition is a service condition or performance condition. For example,
vesting conditions for certain nonemployee awards may be tied to specific tasks and activities (e.g.,
promoting the entity’s products at a defined number of events) rather than to the provision of service
for a specified period. In such circumstances, those specific tasks and activities may represent service
conditions instead of performance conditions. To meet the definition of a performance condition,
the vesting requirement must be related to the grantor’s operations or activities, not the grantee’s.
Therefore, certain tasks and activities that a nonemployee must perform (e.g., quality-control services
that include an assessment of a minimum number of locations each year) to vest in awards may be
characterized as service conditions because they are not solely related to the grantor’s own operations
or activities.
Example 9-3
Entity B grants 100 warrants to a distributor that is not a customer (i.e., it is a vendor). The warrants will vest as
long as the distributor provides B’s products at 20 of its locations for two years. In addition, if the distributor
generates $100 million in sales for B during that two-year period, an additional 100 warrants will vest. While
the maintenance of B’s products at 20 of the distributor’s locations and the generation of $100 million in sales
for B are both related to the distributor’s performance, B would need to assess whether each vesting condition
is a service or performance condition. B may reasonably conclude that maintaining its products at 20 of the
distributor’s locations is a service condition and that achieving $100 million in sales to earn additional warrants
is a performance condition. While achievement of $100 million in sales for B is associated with the distributor’s
service and performance, such performance is related solely to B’s own operations. By contrast, maintaining B’s
products at 20 of the distributor’s locations may not be related solely to B’s own operations and may therefore
be treated as a service condition.
374
9.4 Measurement
ASC 718-10
Objectives
ownership plans.
Fair-Value-Based
30-3 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.
Measurement Objective — Fair Value at Grant Date

30-6 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.
30-7 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).
30-8 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.
30-9 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 718-10-55-4
through 55-47 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
375
In a manner similar to employee awards, nonemployee awards are recognized on the basis of their fair-
value-based measure (and in certain circumstances, nonpublic entities are permitted to use calculated
value or intrinsic value; see discussions in Sections 9.4.2.2 and 9.4.2.3).
9.4.1 Contractual Term Versus Expected Term

ASC 718-10

30-10 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).
As discussed in Section 4.9.2.2, an entity measures employee stock options under ASC 718 by using
an expected term that takes into account the effects of employees’ expected exercise and postvesting
employment termination behavior. ASC 718-10-55-29 states that the expected term is used because
employee stock options differ from transferable or tradable 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.” However, determining an expected term
for nonemployee awards could be challenging because entities may not have sufficient historical data
related to the early exercise behavior of nonemployees, particularly if nonemployee awards are not
frequently granted. In addition, nonemployee stock option awards may not be exercised before the end
of the contractual term if they do not contain certain features typically found in employee stock option
awards (e.g., nontransferability, nonhedgeability, and truncation of the contractual term because of
postvesting termination).
Accordingly, ASC 718 allows an entity to elect on an award-by-award basis to use the contractual term
as the expected term for nonemployee awards. If an entity elects not to use the contractual term for
a particular award, the entity estimates the expected term. However, a nonpublic entity can make an
accounting policy election to apply a practical expedient to estimate the expected term for awards that
meet the conditions in ASC 718-10-30-20B (see discussion in Section 9.4.2.1).
9.4.2 Practical Expedients for Nonpublic Entities

Under ASC 718, nonpublic entities may apply the same practical expedients to nonemployee awards
that they apply to employee awards.
376
9.4.2.1 Expected Term
ASC 718-10

30-10B 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.
30-20A 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 718-10-55-69 through
55-79 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.
30-20B 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.
377

55-29A 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.
As discussed in Section 9.4.1, an entity may make an award-by-award election to use the contractual
term as the expected term. If the contractual term is not used and a nonpublic entity instead estimates
the expected term, the entity may elect to estimate the expected term by using a practical expedient
for nonemployee awards that meet the conditions in ASC 718-10-30-20B. The practical expedient
is an entity-wide accounting policy election that must be consistently applied to both employee and
nonemployee awards. In addition, if elected, the practical expedient must be applied to all nonemployee
awards that meet the conditions in ASC 718-10-30-20B and for which the entity did not first elect to
use the contractual term as the expected term. Under the practical expedient, the expected term is
generally estimated as the midpoint between the nonemployee’s vesting period and the contractual
term of the award. However, the midpoint is not used if an award has an implicit vesting period and
a performance condition and it is not probable that the performance condition will be met. In this
circumstance, the expected term is the contractual term.
See Section 4.9.2.2.3 for further discussion of the expected-term practical expedient.
Example 9-4
Entity D enters into a contract with an advertising company that provides marketing services in exchange
for warrants. In accordance with the terms of the award, the number of warrants earned will depend on the
market price of D’s common shares when the marketing services are completed. For this award, D elects not
to use the contractual term as the expected term. In addition, D has made an entity-wide accounting policy
election to use the practical expedient to estimate the expected term for awards that meet the required
conditions. Therefore, D reviews the guidance in ASC 718-10-30-20B to determine whether it should use the
practical expedient to estimate the expected term. Because the warrants include a market condition, the
practical expedient cannot be applied, and D must estimate the expected term.
9.4.2.2 Calculated Value
ASC 718-10
30-19A 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
378
30-20 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
718-10-55-51 through 55-58 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.
Under ASC 718, a nonpublic entity is required to use calculated value to measure its stock options
and similar instruments granted to employees if it is unable to reasonably estimate the fair value of
such awards because it is not practicable for it to estimate the expected volatility of its stock price. This
practical expedient also applies to nonemployee awards and needs to be consistently applied to both
employee and nonemployee awards. See Section 4.13.2 for further discussion of calculated value.
9.4.2.3 Intrinsic Value
ASC 718-30
Under ASC 718, the accounting policy election permitting nonpublic entities to measure all liability-
classified share-based payment awards at intrinsic value instead of a fair-value-based measure
applies to both employee awards and nonemployee awards, with the exception of measuring liability-
classified share-based payments issued as sales incentives to customers (see Chapter 14 for additional
information about sales incentives to customers). This practical expedient must be consistently applied
to both employee and nonemployee awards.
9.5 Classification
ASC 718-10
379
following:
conditions are met:
manner.
35-11 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.
380
ASC 470-20
Convertible Instruments Issued to Nonemployees for Goods and Services

05-12 A convertible instrument that is issued to a nonemployee in exchange for goods or services or a
combination of goods or services and cash and may contain a nondetachable conversion option that permits
the holder to convert the instrument into the issuer’s stock. This Subtopic provides related guidance.
Editor’s Note: Paragraph 470-20-05-12 will be superseded upon transition, together with its heading:


25-17 The guidance in the following paragraph and paragraph 470-20-25-19 addresses a convertible
instrument that is issued or granted to a nonemployee in exchange for goods or services or a combination
of goods or services and cash. The convertible instrument contains a nondetachable conversion option that
permits the holder to convert the instrument into the issuer’s stock.

381
25-18 Once the instrument is considered issued for accounting purposes pursuant to Subtopic 718-10,
distributions paid or payable shall be characterized as financing costs (that is, interest expense or dividends).
Before that time, distributions paid or payable under the instrument shall be characterized as a cost of the
underlying goods or services.
25-19 If the convertible instrument is issued for cash proceeds that indicate that the instrument includes a
beneficial conversion feature and the purchaser of the instrument also provides (receives) goods or services to
(from) the issuer that are the subject of a separate contract, the convertible instrument shall be recognized with
a corresponding increase or decrease in the purchase or sales price of the goods or services.
Convertible Instruments Issued to Nonemployees for Goods and Services or as Consideration

Payable to a Customer
30-22 To determine the fair value of a convertible instrument granted as part of a share-based payment
transaction to a nonemployee in exchange for goods or services or as consideration payable to a customer that
is equity in form or, if debt in form, that can be converted into equity instruments of the issuer, the entity shall
first apply Topic 718 on stock compensation.
Convertible Instruments Issued to Nonemployees for Goods and Services or as Consideration

Payable to a Customer
30-23 The requirements of this Subtopic shall then be applied such that the fair value determined pursuant
to Topic 718 is considered the proceeds from issuing the instrument for purposes of determining whether a
beneficial conversion option exists. The measurement of the intrinsic value, if any, of the conversion option
under paragraph 470-20-25-5 shall then be computed by comparing the proceeds received for the instrument
(the instrument’s fair value under Topic 718) to the fair value of the common stock that the grantee would
receive upon exercising the conversion option. For purposes of determining whether a convertible instrument
contains a beneficial conversion feature under paragraph 470-20-25-5, an entity shall use the effective
conversion price based on the proceeds allocated to the convertible instrument to compute the intrinsic value,
if any, of the embedded conversion option.
382
30-24 Topic 718 shall be used both to measure the fair value of the convertible instrument and to measure
the intrinsic value, if any, of the conversion option as of the date the convertible instrument granted as part of
a share-based payment award becomes fully vested. That is, in measuring the intrinsic value of the conversion
option under paragraph 470-20-25-5, the fair value of the issuer’s equity securities into which the instrument
can be converted shall be determined as of the date the convertible instrument granted as part of a share-
based payment award becomes fully vested, and not on the commitment date specified in this Subtopic.
30-25 Both of the following guidelines for determining the fair value of convertible instruments shall be used:
a. Subparagraph superseded by Accounting Standards Update No. 2018-07
b. Recent issuances of similar convertible instruments for cash to parties that only have an investor
relationship with the issuer may provide the best evidence of fair value of the convertible instrument.
c. If reliable information under (b) is not available, the fair value of the convertible instrument shall be
deemed to be no less than the fair value of the equity shares into which it can be converted.
30-26 If an entity issues a convertible instrument for cash proceeds that indicate that the instrument includes
a beneficial conversion option and the purchaser of the instrument also provides (receives) goods or services
to (from) the issuer that are the subject of a separate contract, the terms of both the agreement for goods or
services and the convertible instrument shall be evaluated to determine whether their separately stated pricing
is equal to the fair value of the goods or services and convertible instrument. If that is not the situation, the
terms of the respective transactions shall be adjusted by measuring the convertible instrument initially at its
fair value with a corresponding increase or decrease in the purchase or sales price of the goods or services.
It may be difficult to evaluate whether the separately stated pricing of a convertible instrument is equal to its
fair value. If an instrument issued to a goods or services provider (or purchaser) is part of a larger issuance,
a substantive investment in the issuance by unrelated investors (who are not also providers or purchasers of
goods or services) may provide evidence that the price charged to the goods or services provider represents
the fair value of the convertible instrument.
The guidance in ASC 718 on the classification of employee share-based payment awards also applies
to nonemployee awards. Therefore, nonemployee awards will generally remain within the scope of ASC
718 unless they are modified after the awards vest and the nonemployee is no longer providing goods
and services (except under an equity restructuring that meets certain criteria). See Chapter 5 for a
discussion of the guidance on the classification of share-based payment awards.
An exception, however, is a nonemployee award that is granted in the form of a convertible instrument
and was originally within the scope of ASC 718. Such an award is subject to other guidance in U.S. GAAP
once it vests, including ASC 815 and ASC 470-20. If the convertible instrument is subject to ASC 470-20,
the measurement of any beneficial conversion option at intrinsic value is determined on the vesting
date.
383
Changing Lanes
In August 2020, the FASB issued ASU 2020-06, which simplifies the accounting for certain
financial instruments with characteristics of liabilities and equity, including convertible
instruments and contracts on an entity’s own equity. Most of the guidance in that ASU does
not apply to this Roadmap. However, the ASU removes from U.S. GAAP the guidance on a
nonemployee award that is granted in the form of a convertible instrument described in ASC
718-10-35-9A. Therefore, upon adoption of the ASU, nonemployee awards in the form of a
convertible instrument will generally remain within the scope of ASC 718 unless the awards are
modified after the awards vest and the nonemployee is no longer providing goods and services
(except under an equity restructuring that meets certain criteria).
See Deloitte’s August 5, 2020, Heads Up for additional information about changes required
under the ASU, including its effective dates.
For additional discussion of the issuer’s accounting for convertible debt after the adoption of
ASU 2020-06, see Deloitte’s Roadmap Issuer’s Accounting for Debt.
9.6 Nonemployee Awards Exchanged in a Business Combination

ASC 805-30
55-9A The portion of a nonemployee replacement award attributable to precombination vesting is based
on the fair-value-based measure of the acquiree award multiplied by the percentage that would have been
recognized had the grantor paid cash for the goods or services instead of paying with a nonemployee award.
For this calculation, the percentage that would have been recognized is the lower of:
a. The percentage that would have been recognized calculated on the basis of the original vesting
requirements of the nonemployee award
b. The percentage that would have been recognized calculated on the basis of the effective vesting
requirements. Effective vesting requirements are equal to the services or goods provided before the
acquisition date plus any additional postcombination services or goods required by the replacement
award.
55-10 The portion of a nonvested replacement award (for employee and nonemployee) attributable to
postcombination vesting, and therefore recognized as compensation cost in the postcombination financial
statements, equals the total fair-value-based measure of the replacement award less the amount attributed to
precombination vesting. Therefore, the acquirer attributes any excess of the fair-value-based measure of the
replacement award over the fair value of the acquiree award to postcombination vesting and recognizes that
excess as compensation cost in the postcombination financial statements.
384
55-11 Regardless of the accounting policy elected in accordance with paragraph 718-10-35-1D or 718-10-
35-3, the portion of a nonvested replacement award included in consideration transferred shall reflect the
acquirer’s estimate of the number of replacement awards for which the service is expected to be rendered or
the goods are expected to be delivered (that is, an acquirer that has elected an accounting policy to recognize
forfeitures as they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3 should estimate the
number of replacement awards for which the service is expected to be rendered or the goods are expected
to be delivered when determining the portion of a nonvested replacement award included in consideration
transferred). For example, if the fair-value-based measure of the portion of a replacement award attributed to
precombination vesting is $100 and the acquirer expects that the service will be rendered for only 95 percent
of the instruments awarded, the amount included in consideration transferred in the business combination is
$95. Changes in the number of replacement awards for which the service is expected to be rendered or the
goods are expected to be delivered are reflected in compensation cost for the periods in which the changes
or forfeitures occur — not as adjustments to the consideration transferred in the business combination.
If an acquirer’s accounting policy is to account for forfeitures as they occur, the amount excluded from
consideration transferred (because the service is not expected to be rendered or the goods are not expected
to be delivered) should be attributed to the postcombination vesting and recognized in compensation cost over
the employee’s requisite service period or the nonemployee’s vesting period. Recognition of compensation
cost for nonemployees should consider the recognition guidance provided in paragraph 718-10-25-2C. That
is, recognition of the fair value of the nonemployee share-based payment award should be recognized 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 awards.
When nonemployee awards are exchanged in a business combination, it is important for an entity
to determine what portion of the replacement awards is attributed to “precombination vesting” (and
therefore included in the consideration transferred) and what portion is attributed to “postcombination
vesting” (and therefore recognized in the postcombination period). Unlike the computation of ratably
recognized employee awards, the computation of the portion of the replacement awards attributed to
the consideration transferred and the portion attributed to the postcombination period is based on the
percentage of the cost of the awards that would have been recognized in each period if the grantor had
paid cash. Below are examples from ASC 805 illustrating how an acquirer that has provided replacement
awards to nonemployees of an acquiree would attribute such replacement awards to precombination
vesting and postcombination vesting.
ASC 805-30
Example 3: Acquirer Replacement of Nonemployee Awards

55-25 The following Cases illustrate the guidance referred to in paragraph 805-30-55-6 for replacement awards
that the acquirer was obligated to issue and the attribution guidance for a nonemployee replacement award to
precombination and postcombination vesting referenced in paragraph 805-30-55-9A.
55-26 In these Cases, the acquiring entity is referred to as Acquirer and the acquiree is referred to as Target:
a. Awards that require no postcombination vesting that are exchanged for acquiree awards for which
grantees:
1. Have met the vesting condition as of the acquisition date (Case A)
2. Have not met the vesting condition as of the acquisition date (Case D).
b. Awards that require postcombination vesting that are exchanged for acquiree awards for which
grantees:
1. Have met the vesting condition as of the acquisition date (Case B)
2. Have not met the vesting condition as of the acquisition date (Case C).
385
55-27 The Cases assume the following:

a. All awards are classified as equity.
b. The only vesting condition included in the awards, if any, involves the delivery of engines.
c. Target and Acquirer typically pay cash as each engine is delivered to their suppliers.
Case A: No Required Postcombination Vesting and the Vesting Condition for Acquiree Awards Has Been
Met as of Acquisition Date
55-28 Acquirer issues replacement awards of $110 (fair-value-based measure) at the acquisition date for Target
awards of $100 (fair-value-based measure) at the acquisition date. No postcombination vesting is required for
the replacement awards, and Target’s grantee has delivered all the engines necessary for the acquiree awards
as of the acquisition date.
55-29 The amount attributable to precombination vesting is the fair-value-based measure of Target’s awards
($100) at the acquisition date; that amount is included in the consideration transferred in the business
combination. The amount attributable to postcombination vesting is $10, which is the difference between the
total value of the replacement awards ($110) and the portion attributable to precombination vesting ($100).
Because no postcombination vesting is required for the replacement awards, Acquirer immediately recognizes
$10 as compensation cost in its postcombination financial statements.
Case B: Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Been Met as
of Acquisition Date
55-30 Acquirer exchanges replacement awards that require the delivery of another 10 engines
postcombination for share-based payment awards of Target for which the grantee had met the necessary
vesting condition to deliver 40 engines before the business combination. The fair-value-based measure of both
awards is $100 at the acquisition date. Even though the grantee already had met the vesting condition for the
acquiree’s award, Acquirer attributes a portion of the replacement award to postcombination compensation
cost in accordance with paragraphs 805-30-30-12 through 30-13 because the replacement awards require the
delivery of an additional 10 engines.
55-31 The portion attributable to precombination vesting equals the fair-value-based measure of the acquiree
award ($100) multiplied by the percentage that would have been recognized for the award. The percentage that
would have been recognized is the lower of the calculation on the basis of the original vesting requirements
and the percentage that would have been recognized on the basis of the effective vesting requirements as
described in paragraph 805-30-55-9A. The percentage that would have been recognized on the basis of the
original vesting requirements equals 100 percent, which is calculated as 40 engines delivered divided by 40
engines required to be delivered. The percentage that would have been recognized on the basis of the effective
vesting requirements equals 80 percent, which is calculated as 40 engines delivered divided by 50 engines (the
sum of 40 engines delivered plus 10 engines required postcombination). Thus, $80 ($100 × 80%) is attributed
to the precombination vesting period and therefore is included in the consideration transferred in the business
combination. The remaining $20 is attributed to the postcombination vesting period and therefore is recognized
as compensation cost in Acquirer’s postcombination financial statements in accordance with Topic 718.
Case C: Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Not Been
55-32 Acquirer exchanges replacement awards that require the delivery of 10 engines postcombination for
share-based payment awards of Target for which the grantee had not met the necessary vesting condition to
deliver 40 engines before the business combination. The fair-value-based measure of both awards is $100 at
the acquisition date. As of the acquisition date, Target grantee has delivered 20 engines, and Target grantee
would have been required to deliver an additional 20 engines after the acquisition date for its awards to vest.
Accordingly, only a portion of Target’s awards is attributable to precombination vesting.
386
award ($100) multiplied by the percentage that would have been recognized on the award. The percentage
that would have been recognized is the lower of the percentage that would have been recognized on the
basis of the original vesting requirements and the percentage that would have been recognized on the
basis of the effective vesting requirements as described in paragraph 805-30-55-9A. The percentage that
would have been recognized on the basis of the original vesting requirements equals 50 percent, which
is calculated as 20 engines delivered divided by 40 engines required to be delivered. The percentage that
would have been recognized on the basis of the effective vesting requirements equals 66.67 percent, which
is calculated as 20 engines delivered divided by 30 engines (the sum of 20 engines delivered plus 10 engines
required postcombination). Thus, $50 ($100 × 50%) is attributed to precombination vesting and therefore is
included in the consideration transferred in the business combination. The remaining $50 is attributed to the
postcombination vesting and therefore is recognized as compensation cost in Acquirer’s postcombination
financial statements in accordance with Topic 718.
Case D: No Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Not
Been Met as of Acquisition Date
55-34 Assume the same facts as in Case C, except that Acquirer exchanges replacement awards that require
no postcombination vesting for share-based payment awards of Target for which the grantee had not met the
necessary vesting condition to deliver 40 engines before the business combination. The terms of the replaced
Target awards did not eliminate the vesting condition upon a change in control. (If the Target awards had
included a provision that eliminated the vesting condition upon a change in control, the guidance in Case A [see
paragraph 805-30-55-28] would apply.) The fair-value-based measure of both awards is $100.
basis of the original vesting requirements and the percentage that would have been recognized on the basis
of the effective vesting requirements as described in paragraph 805-30-55-9A. The percentage that would
have been recognized on the basis of the original vesting requirements equals 50 percent, which is calculated
as 20 engines delivered divided by 40 engines required to be delivered. The percentage that would have
been recognized on the basis of the effective vesting requirements equals 100 percent, which is calculated
as 20 engines delivered divided by 20 engines (the sum of 20 engines delivered plus zero engines required
postcombination). Thus, $50 ($100 × 50%) is attributed to the precombination vesting and is therefore
included in the consideration transferred in the business combination. The remaining $50 is attributed to
the postcombination vesting. Because no postcombination vesting is required to vest in the replacement
award, Acquirer recognizes the entire $50 immediately as compensation cost in the postcombination financial
statements.
9.7 Presentation
ASC 718-10
35-1B 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.
387
45-3 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.
SEC Staff Announcement: Grantor Balance Sheet Presentation of Unvested, Forfeitable Equity Instruments
Granted to a Nonemployee
S99-1 The following is the text of SEC Staff Announcement: Grantor Balance Sheet Presentation of Unvested,
Forfeitable Equity Instruments Granted to a Nonemployee.
The SEC staff has received inquiries on the appropriate balance sheet presentation of arrangements
where unvested, forfeitable equity instruments are issued to an unrelated nonemployee (the
counterparty) as consideration for future services. The arrangements addressed by the staff entitle the
grantor to recover the specific consideration paid, plus a substantial mandatory penalty, as a minimum
measure of damages for counterparty nonperformance. Consequently, pursuant to paragraph 505-50-
30-12, sufficiently large disincentives for counterparty nonperformance exist such that a performance
commitment and measurement date have been achieved as of the date of issuance. The fair value of
these arrangements is measured in accordance with paragraph 505-50-30-6. Practice appears mixed as
to whether such transactions are recorded at the measurement date. Some registrants make no entries
until performance occurs, while others record the fair value of the equity instruments as equity at the
measurement date and record the offset either as an asset or as a reduction of stockholders’ equity
(contra-equity). This announcement sets forth the SEC staff’s position on the appropriate accounting at the
measurement date.
In evaluating the appropriate balance sheet classification for the above arrangements, the staff considered
the following guidance:
• Paragraph 505-50-25-4, which states that the guidance does not address the period(s) or the
manner (that is, capitalize versus expense) in which an enterprise should recognize the fair value
of equity instruments that were issued, other than to reach a consensus that an asset or expense
should be recognized in the same period(s) and in the same manner (capitalize or expense) as if
the enterprise had paid cash for the goods or services instead of issuing equity instruments.
The SEC staff believes that if the issuer receives a right to receive future services in exchange for unvested,
forfeitable equity instruments, those equity instruments should be treated as unissued for accounting
purposes until the future services are received (that is, the instruments are not considered issued until
they vest). Consequently, there would be no recognition at the measurement date and no entry should be
recorded.
If an entity receives a recourse note for the issuance of a share-based payment award, that note would
generally be presented as contra-equity (see Section 12.1.1). However, if an entity receives an asset that
is not a note or a receivable from a nonemployee supplier or service provider (e.g., an asset received in
return for fully vested, nonforfeitable equity instruments), that asset should not be presented as contra-
equity. In addition, the SEC staff has clarified that unvested, forfeitable instruments should be treated as
unissued for accounting purposes until the future services are received. We believe that this guidance
applies equally to unvested, forfeitable equity instruments associated with goods. Although the SEC Staff
Announcement refers to ASC 505-50, which has been superseded by ASU 2018-07, we believe that the
guidance remains applicable after adoption of the ASU.
388
9.8 Disclosures
There are no specific or incremental disclosure requirements for nonemployee share-based payment
arrangements because the disclosures in ASC 718 apply equally to employee and nonemployee awards.
Under ASC 718-10-50-2(g), separate disclosures for nonemployee awards would be required “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.” See Chapter 13 for additional guidance
on disclosures about share-based payment awards.
9.9 Nonemployees of an Equity Method Investee

ASC 323-10

25-5 In the circumstances described in paragraph 323-10-25-3, other equity method investors in an investee (that
is, noncontributing investors) shall recognize income equal to the amount that their interest in the investee’s net
book value has increased (that is, their percentage share of the contributed capital recognized by the investee) as
a result of the disproportionate funding of the compensation costs. Further, those other equity method investors
shall recognize their percentage share of earnings or losses in the investee (inclusive of any expense recognized
by the investee for the share-based compensation funded on its behalf).
25-6 Example 2 (see paragraph 323-10-55-19) illustrates the application of this guidance for share-based
compensation granted to employees of an equity method investee.
Share-Based Compensation Granted to Employees and Nonemployees of an Equity Method Investee

30-3 Share-based compensation cost recognized in accordance with paragraph 323-10-25-4 shall be measured
initially at fair value in accordance with Topic 718. Example 2 (see paragraph 323-10-55-19) illustrates the
application of this guidance.
389
Example 2: Share-Based Compensation Granted to Employees of an Equity Method Investee

55-19 This Example illustrates the guidance in paragraphs 323-10-25-3 and 323-10-30-3 for share-based
compensation by an investor granted to employees of an equity method investee. This Example is equally
applicable to share-based awards granted by an investor to nonemployees that provide goods or services to an
equity method investee that are used or consumed in the investee’s operations.
55-20 Entity A owns a 40 percent interest in Entity B and accounts for its investment under the equity method.
On January 1, 20X1, Entity A grants 10,000 stock options (in the stock of Entity A) to employees of Entity B.
The stock options cliff-vest in three years. If an employee of Entity B fails to vest in a stock option, the option
is returned to Entity A (that is, Entity B does not retain the underlying stock). The owners of the remaining 60
percent interest in Entity B have not shared in the funding of the stock options granted to employees of Entity
B on any basis and Entity A was not obligated to grant the stock options under any preexisting agreement with
Entity B or the other investors. Entity B will capitalize the share-based compensation costs recognized over
the first year of the three-year vesting period as part of the cost of an internally constructed fixed asset (the
internally constructed fixed asset will be completed on December 31, 20X1).
55-21 Before granting the stock options, Entity A’s investment balance is $800,000, and the book value of Entity
B’s net assets equals $2,000,000. Entity B will not begin depreciating the internally constructed fixed asset until
it is complete and ready for its intended use and, therefore, no related depreciation expense (or compensation
expense relating to the stock options) will be recognized between January 1, 20X1, and December 31, 20X1. For
the years ending December 31, 20X2, and December 31, 20X3, Entity B will recognize depreciation expense (on
the internally constructed fixed asset) and compensation expense (for the cost of the stock options relating to
Years 2 and 3 of the vesting period). After recognizing those expenses, Entity B has net income of $200,000 for
the fiscal years ending December 31, 20X1, December 31, 20X2, and December 31, 20X3.
55-22 Entity C also owns a 40 percent interest in Entity B. On January 1, 20X1, before granting the stock options,
Entity C’s investment balance is $800,000.
55-23 Assume that the fair value of the stock options granted by Entity A to employees of Entity B is $120,000
on January 1, 20X1. Under Topic 718, the fair value of share-based compensation should be measured at the
grant date. This Example assumes that the stock options issued are classified as equity and ignores the effect of
forfeitures.
390
55-24 Entity A would make the following journal entries.
12/31/20X1 12/31/20X2 12/31/20X3
To record cost of stock compensation and Entity C’s additional investment for costs incurred by Entity A on
behalf of investee
Entity A (Contributing Investor)

Investment in Entity B(a) $ 16,000 $ 16,000 $ 16,000
Expense (b)
24,000 24,000 24,000
Entity B (investee)
Fixed asset $ 40,000 — —
Expense — $ 40,000 $ 40,000
Entity C (noncontributing investor)

Contribution income (c)
$ 16,000 $ 16,000 $ 16,000
To record Entity A’s and Entity C’s share of the earnings of investee (same entry for both Entity A and Entity C)
Entity A and Entity C

Equity in earnings of Entity B $ 80,000 $ 80,000 $ 80,000
Consolidated impact of all the entries made by Entity A and Entity C
Entity A
Expense 24,000 24,000 24,000
Entity C
Contribution income $ 16,000 $ 16,000 $ 16,000
(a) Entity A recognizes as an expense the portion of the costs incurred that benefits the other investors (in this Example, 60 percent of the
cost or $24,000 in 20X1, 20X2, and 20X3) and recognizes the remaining cost (40 percent) as an increase to the investment in Entity B. As
Entity B has recognized the cost associated with the stock-based compensation incurred on its behalf, the portion of the cost recognized
by Entity A as an increase to its investment in Entity B (40 percent) is expensed in the appropriate period when Entity A recognizes its
share of the earnings of Entity B.
(b) It may be appropriate to classify the debit (expense) within the same income statement caption as equity in earnings of Entity B.
(c) This amount represents Entity C’s 40 percent interest in the additional paid-in capital recognized by Entity B related to the cost incurred
by the third-party investor. It may be appropriate to classify the credit (income) within the same income statement caption as equity in
earnings of Entity B.
391
55-25 A rollforward of Entity B’s net assets and a reconciliation to Entity A’s and Entity C’s ending investment
accounts follows.
12/31/20X1 12/31/20X2 12/31/20X3
Net assets of Entity B

Beginning net assets $ 2,000,000 $ 2,240,000 $ 2,480,000
Contributed capital 40,000 40,000 40,000
Net income 200,000 200,000 200,000
Ending net assets $ 2,240,000 $ 2,480,000 $ 2,720,000
Entity A’s and Entity C’s share × 40% × 40% × 40%
Entity A’s and Entity C’s equity in net assets of Entity B 896,000 992,000 1,088,000
Entity A’s and Entity C’s ending investment balance 896,000 992,000 1,088,000
Remaining unamortized basis difference $ — $ — $ —
55-26 A summary of the calculation of share-based compensation cost by year follows.
Calculation of the Share-Based Compensation Cost by Year
A = Grant C = (A × B) Amount
Date Fair of Cumulative D = Cumulative E=C–D
Year Value of B=% Compensation Cost Cost Previously Current Year
Ended Options Vested to Be Recognized Recognized Cost
20X1 $ 120,000 33% $ 40,000 $ — $ 40,000
20X2 $ 120,000 66% $ 80,000 $ 40,000 $ 40,000
20X3 $ 120,000 100% $ 120,000 $ 80,000 $ 40,000
ASC 323 provides guidance on share-based payment awards that are issued by an equity method
investor to employees and nonemployee goods or service providers of an equity method investee and
are indexed to, or settled in, the equity of the investor.
392
Chapter 10 — Business Combinations
In a business combination, share-based payment awards held by grantees of the acquiree are often
exchanged for share-based payment awards of the acquirer. ASC 805 refers to the new awards as
“replacement awards.” The acquirer must analyze the terms of both the preexisting and the replacement
awards to determine what portion of the replacement awards is related to precombination vesting (i.e.,
past goods or services) and therefore part of the consideration transferred in the business combination.
The portion of replacement awards that is related to postcombination vesting (i.e., future goods or
services) should be recognized as compensation cost in the postcombination period.
10.1 Replacement of Acquiree Awards

ASC 718-20

ASC 805-30
Acquirer Share-Based Payment Awards Exchanged for Awards Held by the Acquiree’s Grantees
30-9 An acquirer may exchange its share-based payment awards for awards held by grantees of the acquiree.
This Topic refers to such awards as replacement awards. Exchanges of share options or other share-based
payment awards in conjunction with a business combination are modifications of share-based payment
awards in accordance with Topic 718. If the acquirer is obligated to replace the acquiree awards, either all or a
portion of the fair-value-based measure of the acquirer’s replacement awards shall be included in measuring
the consideration transferred in the business combination. The acquirer is obligated to replace the acquiree
awards if the acquiree or its grantees have the ability to enforce replacement. For example, for purposes of
applying this requirement, the acquirer is obligated to replace the acquiree’s awards if replacement is required
by any of the following:
a. The terms of the acquisition agreement
b. The terms of the acquiree’s awards
c. Applicable laws or regulations.
30-10 In situations in which acquiree awards would expire as a consequence of a business combination and the
acquirer replaces those awards even though it is not obligated to do so, all of the fair-value-based measure of
the replacement awards shall be recognized as compensation cost in the postcombination financial statements.
That is, none of the fair-value-based measure of those awards shall be included in measuring the consideration
transferred in the business combination.
393
Exchanges of share-based payment awards in a business combination are considered modifications

under ASC 718. An acquirer must assess whether the replacement awards are part of the consideration
transferred, are recognized as compensation cost in the postcombination financial statements, or are
a combination of both in accordance with ASC 805. Before it can make its determination, the acquirer
must assess whether it is “obligated” to replace the acquiree’s awards. If it is obligated to replace the
awards, the acquirer must include all or a portion of the fair-value-based measure1 of the replacement
awards in its measurement of the consideration transferred in the business combination. The portion
not included in the measurement of consideration transferred is included in postcombination
compensation cost.
ASC 805-30-30-9 notes that the acquirer is obligated to replace the acquiree’s share-based payment
awards “if the acquiree or its grantees have the ability to enforce replacement.” It further indicates
that the acquirer is obligated to replace the awards if replacement is required by (1) the terms of the
acquisition agreement, (2) the terms of the acquiree’s awards, or (3) applicable laws or regulations. It
is not uncommon for the terms of the acquiree’s awards to be silent or give the acquiree discretion
regarding the awards’ treatment upon a business combination. If an obligation to replace the acquiree’s
awards is based on the terms of the acquisition agreement, acquirers should carefully consider the
awards’ preexisting terms to determine the portion of the fair-value-based-measure to include in the
consideration transferred and in postcombination compensation cost. In addition, acquirers may wish
to consult with legal counsel for assistance in assessing the terms of award agreements and their
requirements under applicable laws and regulations.
If an acquiree’s share-based payment awards expire as a result of the business combination, and
the acquirer issues replacement awards even though it is not obligated to do so, the transaction is
generally considered to be separate from the business combination. In that case, the entire fair-value-
based measure of the awards is considered compensation cost in the postcombination period and is
accounted for as a new award in accordance with ASC 718.
See Section 10.2 for additional information about allocating replacement awards between consideration
transferred and postcombination compensation cost.
10.2 Allocating Replacement Awards Between Consideration Transferred

and Postcombination Compensation Cost
ASC 805-30
30-11 To determine the portion of a replacement award that is part of the consideration transferred for the
acquiree, the acquirer shall measure both the replacement awards granted by the acquirer and the acquiree
awards as of the acquisition date in accordance with Topic 718. The portion of the fair-value-based measure
of the replacement award that is part of the consideration transferred in exchange for the acquiree equals the
portion of the acquiree award that is attributable to precombination vesting.
30-12 The acquirer shall attribute a portion of a replacement award to postcombination vesting if it requires
postcombination vesting, regardless of whether grantees had rendered all of the service or delivered all of the
goods required in exchange for their acquiree awards before the acquisition date. The portion of a nonvested
replacement award attributable to postcombination vesting equals the total fair-value-based measure of
the replacement award less the amount attributed to precombination vesting. Therefore, the acquirer shall
attribute any excess of the fair-value-based measure of the replacement award over the fair value of the
acquiree award to postcombination vesting.
1
While the term “fair-value-based measure” is used in this chapter, ASC 718 permits the use of a calculated value or an intrinsic value in specified
circumstances. Accordingly, the guidance in this chapter also applies in situations in which a calculated or an intrinsic value is used.
394
30-13 Paragraphs 805-30-55-6 through 55-13, 805-740-25-10 through 25-11, 805-740-45-5 through 45-6, and
Example 2 (see paragraph 805-30-55-17) provide additional guidance and illustrations on distinguishing between
the portion of a replacement award that is attributable to precombination vesting, which the acquirer includes in
the consideration transferred in the business combination, and the portion that is attributed to postcombination
vesting, which the acquirer recognizes as compensation cost in its postcombination financial statements.
Replacement Share-Based Payment Awards

35-3 Topic 718 provides guidance on subsequent measurement and accounting for the portion of replacement
share-based payment awards issued by an acquirer that is attributable to future goods or services.
Acquirer Share-Based Payment Awards Exchanged for Awards Held by the Grantees of the Acquiree
55-6 If the acquirer is obligated to replace the acquiree’s share-based payment awards, paragraph 805-30-
30-9 requires the acquirer to include either all or a portion of the fair-value-based measure of the replacement
awards in the consideration transferred in the business combination. Paragraphs 805-30-55-7 through
55-13, 805-740-25-10 through 25-11, 805-740-45-5 through 45-6, and Example 2 (see paragraph 805-30-
55-17) provide additional guidance on and illustrate how to determine the portion of an award to include in
consideration transferred in a business combination and the portion to recognize as compensation cost in the
acquirer’s postcombination financial statements.
55-7 To determine the portion of a replacement award that is part of the consideration exchanged for the
acquiree and the portion that is compensation for postcombination vesting, the acquirer first measures
both the replacement awards and the acquiree awards as of the acquisition date in accordance with the
requirements of Topic 718. In most situations, those requirements result in use of the fair-value-based
measurement method, but that Topic permits use of the calculated value method or the intrinsic value
method in specified circumstances. This discussion focuses on the fair-value-based method, but the guidance
in paragraphs 805-30-30-9 through 30-13 and the additional guidance cited in the preceding paragraph also
apply in situations in which Topic 718 permits use of either the calculated value method or the intrinsic value
method for both the acquiree awards and the replacement awards.
55-8 The portion of an employee replacement award attributable to precombination vesting is the fair-value-
based measure of the acquiree award multiplied by the ratio of the precombination employee’s service period
to the greater of the total service period or the original service period of the acquiree award. (Example 2, Cases
C and D [see paragraphs 805-30-55-21 through 55-24] illustrate that calculation.) The total service period is the
sum of the following amounts:
a. The part of the employee’s requisite service period for the acquiree award that was completed before
the acquisition date
b. The postcombination employee’s requisite service period, if any, for the replacement award.
55-9 The employee’s requisite service period includes explicit, implicit, and derived service periods during which
employees are required to provide service in exchange for the award (consistent with the requirements of
Topic 718).
55-9A The portion of a nonemployee replacement award attributable to precombination vesting is based
on the fair-value-based measure of the acquiree award multiplied by the percentage that would have been
recognized had the grantor paid cash for the goods or services instead of paying with a nonemployee award.
For this calculation, the percentage that would have been recognized is the lower of:
a. The percentage that would have been recognized calculated on the basis of the original vesting
requirements of the nonemployee award
b. The percentage that would have been recognized calculated on the basis of the effective vesting
requirements. Effective vesting requirements are equal to the services or goods provided before the
acquisition date plus any additional postcombination services or goods required by the replacement
award.
395
55-10 The portion of a nonvested replacement award (for employee and nonemployee) attributable to
postcombination vesting, and therefore recognized as compensation cost in the postcombination financial
statements, equals the total fair-value-based measure of the replacement award less the amount attributed to
precombination vesting. Therefore, the acquirer attributes any excess of the fair-value-based measure of the
replacement award over the fair value of the acquiree award to postcombination vesting and recognizes that
excess as compensation cost in the postcombination financial statements.
55-13 The same requirements for determining the portions of a replacement award attributable to
precombination and postcombination vesting apply regardless of whether a replacement award is classified
as a liability or an equity instrument in accordance with the provisions of paragraphs 718-10-25-6 through
25-19A. All changes in the fair-value-based measure of awards classified as liabilities after the acquisition date
and the related income tax effects are recognized in the acquirer’s postcombination financial statements in the
period(s) in which the changes occur.
Illustrations
Example 2: Acquirer Replacement of Employee Awards
that the acquirer was obligated to issue. The Cases assume that all awards are classified as equity and that the
awards have only an explicit service period. As discussed in paragraphs 805-30-55-8 through 55-9, the acquirer
also must take any implicit or derived employee’s service periods into account in determining the employee’s
requisite service period for a replacement award. In these Cases, the acquiring entity is referred to as Acquirer
and the acquiree is referred to as Target:
employees:
1. Have rendered the required service as of the acquisition date (Case A)
2. Have not rendered all of the required service as of the acquisition date (Case D).
employees:
1. Have rendered the required service as of the acquisition date (Case B)
2. Have not rendered all of the required service as of the acquisition date (Case C).
Case A: No Required Postcombination Vesting, All Requisite Service for Acquiree Awards Rendered as of
Acquisition Date
awards of $100 (fair-value-based measure) at the acquisition date. No postcombination vesting is required
for the replacement awards, and Target’s employees had rendered all of the required service for the acquiree
awards as of the acquisition date.
396
Case B: Postcombination Vesting Required, All Requisite Service for Acquiree Awards Rendered as of
Acquisition Date
55-20 Acquirer exchanges replacement awards that require one year of postcombination vesting for share-
based payment awards of Target for which employees had completed the requisite service period before the
business combination. The fair-value-based measure of both awards is $100 at the acquisition date. When
originally granted, Target’s awards had a requisite service period of four years. As of the acquisition date, the
Target employees holding unexercised awards had rendered a total of seven years of service since the grant
date. Even though Target employees had already rendered all of the requisite service, Acquirer attributes a
portion of the replacement award to postcombination compensation cost in accordance with paragraphs
805-30-30-12 through 30-13 because the replacement awards require one year of postcombination vesting.
The total service period is five years — the requisite service period for the original acquiree award completed
before the acquisition date (four years) plus the requisite service period for the replacement award (one year).
The portion attributable to precombination vesting equals the fair-value-based measure of the acquiree award
($100) multiplied by the ratio of the precombination vesting period (4 years) to the total vesting period (5 years).
Thus, $80 ($100 × 4 ÷ 5 years) is attributed to the precombination vesting period and therefore included in the
consideration transferred in the business combination. The remaining $20 is attributed to the postcombination
vesting period and therefore is recognized as compensation cost in Acquirer’s postcombination financial
statements in accordance with Topic 718.
Case C: Postcombination Vesting Required, All Requisite Service for Acquiree Awards Not Rendered as of
Acquisition Date
55-21 Acquirer exchanges replacement awards that require one year of postcombination vesting for share-
based payment awards of Target for which employees had not yet rendered all of the required services as
of the acquisition date. The fair-value-based measure of both awards is $100 at the acquisition date. When
originally granted, the awards of Target had a requisite service period of four years. As of the acquisition date,
the Target employees had rendered two years’ service, and they would have been required to render two
additional years of service after the acquisition date for their awards to vest. Accordingly, only a portion of
Target’s awards is attributable to precombination vesting.
55-22 The replacement awards require only one year of postcombination vesting. Because employees have
already rendered two years of service, the total requisite service period is three years. The portion attributable
to precombination vesting equals the fair-value-based measure of the acquiree award ($100) multiplied by
the ratio of the precombination vesting period (2 years) to the greater of the total service period (3 years)
or the original service period of Target’s award (4 years). Thus, $50 ($100 × 2 ÷ 4 years) is attributable to
precombination vesting and therefore included in the consideration transferred for the acquiree. The
remaining $50 is attributable to postcombination vesting and therefore recognized as compensation cost in
Acquirer’s postcombination financial statements in accordance with Topic 718.
Case D: No Required Postcombination Vesting, All Requisite Service for Acquiree Awards Not Rendered as
of Acquisition Date
55-23 Assume the same facts as in Case C, except that Acquirer exchanges replacement awards that require no
postcombination vesting for share-based payment awards of Target for which employees had not yet rendered
all of the requisite service as of the acquisition date. The terms of the replaced Target awards did not eliminate
any remaining requisite service period upon a change in control. (If the Target awards had included a provision
that eliminated any remaining requisite service period upon a change in control, the guidance in Case A would
apply.) The fair-value-based measure of both awards is $100. Because employees have already rendered two
years of service and the replacement awards do not require any postcombination vesting, the total service
period is two years.
397
55-24 The portion of the fair-value-based measure of the replacement awards attributable to precombination
vesting equals the fair-value-based measure of the acquiree award ($100) multiplied by the ratio of the
precombination vesting period (2 years) to the greater of the total service period (2 years) or the original service
period of Target’s award (4 years). Thus, $50 ($100 × 2 ÷ 4 years) is attributable to precombination vesting
and therefore included in the consideration transferred for the acquiree. The remaining $50 is attributable
to postcombination vesting. Because no postcombination vesting is required to vest in the replacement
statements.
Example 3: Acquirer Replacement of Nonemployee Awards

that the acquirer was obligated to issue and the attribution guidance for a nonemployee replacement award to
precombination and postcombination vesting referenced in paragraph 805-30-55-9A.
55-26 In these Cases, the acquiring entity is referred to as Acquirer and the acquiree is referred to as Target:
grantees:
1. Have met the vesting condition as of the acquisition date (Case A)
2. Have not met the vesting condition as of the acquisition date (Case D).
grantees:
1. Have met the vesting condition as of the acquisition date (Case B)
2. Have not met the vesting condition as of the acquisition date (Case C).
55-27 The Cases assume the following:

a. All awards are classified as equity.
b. The only vesting condition included in the awards, if any, involves the delivery of engines.
c. Target and Acquirer typically pay cash as each engine is delivered to their suppliers.
Case A: No Required Postcombination Vesting and the Vesting Condition for Acquiree Awards Has Been
awards of $100 (fair-value-based measure) at the acquisition date. No postcombination vesting is required for
the replacement awards, and Target’s grantee has delivered all the engines necessary for the acquiree awards
as of the acquisition date.
398
Case B: Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Been Met as
of Acquisition Date
55-30 Acquirer exchanges replacement awards that require the delivery of another 10 engines
postcombination for share-based payment awards of Target for which the grantee had met the necessary
vesting condition to deliver 40 engines before the business combination. The fair-value-based measure of both
awards is $100 at the acquisition date. Even though the grantee already had met the vesting condition for the
acquiree’s award, Acquirer attributes a portion of the replacement award to postcombination compensation
cost in accordance with paragraphs 805-30-30-12 through 30-13 because the replacement awards require the
delivery of an additional 10 engines.
55-31 The portion attributable to precombination vesting equals the fair-value-based measure of the
acquiree award ($100) multiplied by the percentage that would have been recognized for the award. The
percentage that would have been recognized is the lower of the calculation on the basis of the original vesting
requirements and the percentage that would have been recognized on the basis of the effective vesting
requirements as described in paragraph 805-30-55-9A. The percentage that would have been recognized on
the basis of the original vesting requirements equals 100 percent, which is calculated as 40 engines delivered
divided by 40 engines required to be delivered. The percentage that would have been recognized on the basis
of the effective vesting requirements equals 80 percent, which is calculated as 40 engines delivered divided
by 50 engines (the sum of 40 engines delivered plus 10 engines required postcombination). Thus, $80 ($100
× 80%) is attributed to the precombination vesting period and therefore is included in the consideration
transferred in the business combination. The remaining $20 is attributed to the postcombination vesting
period and therefore is recognized as compensation cost in Acquirer’s postcombination financial statements in
accordance with Topic 718.
Case C: Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Not Been
55-32 Acquirer exchanges replacement awards that require the delivery of 10 engines postcombination for
share-based payment awards of Target for which the grantee had not met the necessary vesting condition to
deliver 40 engines before the business combination. The fair-value-based measure of both awards is $100 at
the acquisition date. As of the acquisition date, Target grantee has delivered 20 engines, and Target grantee
would have been required to deliver an additional 20 engines after the acquisition date for its awards to vest.
Accordingly, only a portion of Target’s awards is attributable to precombination vesting.
basis of the original vesting requirements and the percentage that would have been recognized on the
basis of the effective vesting requirements as described in paragraph 805-30-55-9A. The percentage that
would have been recognized on the basis of the original vesting requirements equals 50 percent, which
is calculated as 20 engines delivered divided by 40 engines required to be delivered. The percentage that
would have been recognized on the basis of the effective vesting requirements equals 66.67 percent, which
is calculated as 20 engines delivered divided by 30 engines (the sum of 20 engines delivered plus 10 engines
required postcombination). Thus, $50 ($100 × 50%) is attributed to precombination vesting and therefore is
included in the consideration transferred in the business combination. The remaining $50 is attributed to the
postcombination vesting and therefore is recognized as compensation cost in Acquirer’s postcombination
financial statements in accordance with Topic 718.
399
Case D: No Postcombination Vesting Required and the Vesting Condition for Acquiree Awards Has Not
Been Met as of Acquisition Date
55-34 Assume the same facts as in Case C, except that Acquirer exchanges replacement awards that require
no postcombination vesting for share-based payment awards of Target for which the grantee had not met the
necessary vesting condition to deliver 40 engines before the business combination. The terms of the replaced
Target awards did not eliminate the vesting condition upon a change in control. (If the Target awards had
included a provision that eliminated the vesting condition upon a change in control, the guidance in Case A [see
paragraph 805-30-55-28] would apply.) The fair-value-based measure of both awards is $100.
basis of the original vesting requirements and the percentage that would have been recognized on the basis
of the effective vesting requirements as described in paragraph 805-30-55-9A. The percentage that would
have been recognized on the basis of the original vesting requirements equals 50 percent, which is calculated
as 20 engines delivered divided by 40 engines required to be delivered. The percentage that would have
been recognized on the basis of the effective vesting requirements equals 100 percent, which is calculated
as 20 engines delivered divided by 20 engines (the sum of 20 engines delivered plus zero engines required
postcombination). Thus, $50 ($100 × 50%) is attributed to the precombination vesting and is therefore
included in the consideration transferred in the business combination. The remaining $50 is attributed to
the postcombination vesting. Because no postcombination vesting is required to vest in the replacement
statements.
Replacement share-based payment awards issued by the acquirer may represent consideration
transferred in the business combination if the award is related to precombination vesting (past goods
or services provided), postcombination compensation cost for future vesting (future goods or services
provided), or both.
Entities should carefully analyze any modifications to or replacements of acquiree awards to determine
whether they are part of, or separate from, the business combination. ASC 805-10-25-20 states, in part,
that the “acquirer shall recognize as part of applying the acquisition method only the consideration
transferred for the acquiree and the assets acquired and liabilities assumed in the exchange for the
acquiree. Separate transactions shall be accounted for in accordance with the relevant [GAAP].” In
addition, ASC 805-10-25-21 states, in part, that a “transaction entered into by or on behalf of the
acquirer or primarily for the benefit of the acquirer or the combined entity, rather than primarily for
the benefit of the acquiree (or its former owners) before the combination, is likely to be a separate
transaction.”
400
Further, ASC 805-10-55-18 provides three factors for entities to consider in determining whether the
transaction is part of a business combination or should be accounted for separately (these factors are
not mutually exclusive or individually conclusive).
ASC 805-10
55-18 Paragraphs 805-10-25-20 through 25-22 establish the requirements to identify amounts that are
not part of the business combination. The acquirer should consider the following factors, which are neither
mutually exclusive nor individually conclusive, to determine whether a transaction is part of the exchange for
the acquiree or whether the transaction is separate from the business combination:
a. The reasons for the transaction. Understanding the reasons why the parties to the combination (the
acquirer, the acquiree, and their owners, directors, managers, and their agents) entered into a particular
transaction or arrangement may provide insight into whether it is part of the consideration transferred
and the assets acquired or liabilities assumed. For example, if a transaction is arranged primarily for the
benefit of the acquirer or the combined entity rather than primarily for the benefit of the acquiree or its
former owners before the combination, that portion of the transaction price paid (and any related assets
or liabilities) is less likely to be part of the exchange for the acquiree. Accordingly, the acquirer would
account for that portion separately from the business combination.
b. Who initiated the transaction. Understanding who initiated the transaction may also provide insight into
whether it is part of the exchange for the acquiree. For example, a transaction or other event that is
initiated by the acquirer may be entered into for the purpose of providing future economic benefits to
the acquirer or combined entity with little or no benefit received by the acquiree or its former owners
before the combination. On the other hand, a transaction or arrangement initiated by the acquiree or its
former owners is less likely to be for the benefit of the acquirer or the combined entity and more likely
to be part of the business combination transaction.
c. The timing of the transaction. The timing of the transaction may also provide insight into whether it is
part of the exchange for the acquiree. For example, a transaction between the acquirer and the acquiree
that takes place during the negotiations of the terms of a business combination may have been entered
into in contemplation of the business combination to provide future economic benefits to the acquirer
or the combined entity. If so, the acquiree or its former owners before the business combination are
likely to receive little or no benefit from the transaction except for benefits they receive as part of the
combined entity.
Further, understanding the business purpose of a modification will help an acquirer assess which party
benefits from it. The acquirer should particularly consider terms that accelerate vesting upon a change
in control (see Section 10.4), cash settlement upon a change in control (see Section 10.5), and other
compensation arrangements affected by a change in control (see Section 10.7).
10.2.1 Allocation Steps
The diagram below illustrates the steps in an entity’s determination of the amount to recognize as
consideration transferred in a business combination and as postcombination compensation cost.
Sections 10.2.1.1 through 10.2.1.3 discuss the steps in detail. If the acquiree is not obligated to replace
the acquiree’s awards, and replacement awards are issued, generally the entire replacement award is
accounted for as postcombination compensation cost (see Section 10.1).
401
Is the acquirer
obligated to replace
the acquiree’s
awards?
(See Section 10.1.)
Yes No
Include all or a portion of the fair-value-based

If replacement awards are issued,
measure of the acquirer’s replacement awards
generally account for the entire award as
in the consideration transferred. The portion not
postcombination compensation cost.
included in the consideration transferred is
(See Section 10.1.)
included in postcombination compensation cost.
Step 1: Calculate the fair-value-based measure

of the acquirer’s replacement awards and the
acquiree’s awards being replaced as of the
acquisition date.
Step 2: If the fair-value-based measure of the

replacement awards is greater than the fair-
value-based measure of the replaced awards as
of the acquisition date, attribute the difference to
postcombination compensation cost in accordance
with ASC 718.
Step 3: Calculate the portion of the acquisition

date fair-value-based measure of the replacement
awards that should be attributed to consideration
transferred (i.e., precombination vesting) and the
portion of the fair-value-based measure that should
be attributed to postcombination compensation
cost (i.e., postcombination vesting).
10.2.1.1 Considerations Related to Step 1

The acquirer must determine the fair-value-based measure of both the acquirer’s replacement awards and
the acquiree’s replaced awards as of the acquisition date, in accordance with the guidance in ASC 718.
With few exceptions, ASC 805-20-30-1 requires acquirers to measure assets acquired and liabilities
assumed in a business combination at their acquisition-date fair values. Fair value is determined
by using the guidance in ASC 820. However, share-based payment awards are an exception to
that guidance because, unlike a fair value measure, a fair-value-based measure excludes certain
considerations such as vesting conditions (i.e., service or performance conditions). See Section 4.1 for
additional discussion of the fair-value-based measure method prescribed in ASC 718.
In certain circumstances, ASC 718 also permits the use of a calculated value and an intrinsic value. Those
measurement methods are discussed in Sections 4.13.2 and 4.13.3. If either is used, the acquirer’s
replacement awards and the acquiree’s replaced awards are measured on such a basis.
402

If there is an excess of the fair-value-based measure of the acquirer’s replacement awards over the fair-
value-based measure of the acquiree’s replaced awards as of the acquisition date, incremental value is
recognized as compensation cost in the acquirer’s postcombination financial statements in accordance
with ASC 805-30-30-12. Such cost is recognized over the period from the acquisition date through the
end of the employee’s requisite service period or nonemployee’s vesting period of the replacement
awards. If there is no postcombination vesting requirement, all of the excess is generally recognized
immediately in the postcombination financial statements (i.e., on day 1). This is illustrated in Case A of
Example 2 in ASC 805-30-55-18 and 55-19, which addresses employees, and Case A of Example 3 in
ASC 805-30-55-28 and 55-29, which addresses nonemployees.

10.2.1.3.1 Allocation to Precombination Vesting
The portion of the replacement share-based payment awards that is attributable to precombination
vesting, and therefore included in the consideration transferred, is calculated as follows:
Acquisition-date fair-value-based measure of the acquiree’s replaced awards

Ratio of the precombination vesting to the greater of (1) the total vesting period or (2) the original
× vesting period of the acquiree’s replaced awards
= Amount included in consideration transferred
The practical effect of requiring the use of the greater of the total vesting period or the original vesting
period of the acquiree’s replaced awards is that an acquirer will always reflect at least the proportion of
the compensation cost in the postcombination financial statements, as it would have under the original
terms of the award. In a scenario in which the acquirer accelerates vesting, this “greater of” calculation
is consistent with the accounting for an acceleration of vesting that is determined to primarily benefit
the acquirer, as described in Section 10.4.1. An acquirer’s decision to immediately accelerate vesting of
replacement awards does not decrease its proportion of compensation expense in the postcombination
financial statements but merely accelerates the timing of recognition. This is illustrated in Case D of
Example 2 in ASC 805-30-55-23 and 55-24, which addresses employees, and Case D of Example 3 in
ASC 805-30-55-34 and 55-35, which addresses nonemployees.
The total vesting period is calculated as follows:
Vesting period for the acquiree’s replaced awards completed before the acquisition date
+ Postcombination vesting period, if any, for the acquirer’s replacement awards
= Total vesting period
For employee awards, the requisite service period (i.e., the vesting period) may be explicit, implicit,
or derived and will depend on the terms of the share-based payment awards (see Section 3.6 for
additional information). For nonemployee awards, the vesting period is calculated on the basis of the
percentage that would have been recognized had the grantor paid cash for the goods or services
instead of paying with a nonemployee award.
403
If the acquirer decides to extend the vesting period rather than accelerate vesting, use of the “greater of”
calculation would result in a greater share of the compensation cost attributed to the post-combination
period and is consistent with the increase in grantee services to be provided to the acquirer. For
acquiree awards that were fully vested before the acquisition date and that were replaced by new
awards for which an additional future vesting period is required, the total vesting period is the sum of
the vesting period of the acquiree-replaced awards and the vesting period of the replacement awards.
It excludes the period from the precombination vesting date of the acquiree-replaced awards to the
acquisition date. This is illustrated in Case B of Example 2 in ASC 805-30-55-20, which addresses
employees, and Case B of Example 3 in ASC 805-30-55-30 and 55-31, which addresses nonemployees.
The examples below illustrate how to determine the total service period for employee awards.
Example 10-1
Determining the Total Service Period of a Replacement Award When the Replaced Award Is Fully
Vested
An employee is awarded 100 options on Entity B’s common stock that became fully vested on June 30, 20X1.
A three-year service period was originally associated with this award, but the options have not been exercised
yet. On January 1, 20X2, Entity A acquires B in a transaction accounted for as a business combination and is
obligated to replace the employee’s options. As part of the acquisition, A is obligated to replace B’s fully vested
options with A’s new options that require an additional three years of service.
The total service period of the replacement award is six years, which is the sum of the service period of B’s
original award (the replaced award) plus the service period of A’s new award (the replacement award). The total
service period does not include the period from the original vesting date (i.e., June 30, 20X1) to the acquisition
date (i.e., January 1, 20X2).
Example 10-2
Determining the Total Service Period of Replacement Awards When the Service Period Is the Same
as That for the Replaced Awards
On January 1, 20X1, Entity B grants 100 share-based payment awards to an employee that vest at the end of
the fourth year of service (cliff vesting). On January 1, 20X3, Entity A acquires B in a transaction accounted for
as a business combination and is obligated to replace the employee’s awards with 100 new awards that have
the same service terms as B’s original award (i.e., the replacement awards will vest at the end of two additional
years).
The total service period of the replacement awards is four years, which is equal to the service period of B’s
original awards. In the calculation of the portion attributable to precombination service, the precombination
service period is two years (January 1, 20X1, to January 1, 20X3).
See Section 9.6 for an example of how to determine the total vesting period for nonemployee awards.
10.2.1.3.2 Allocation to Postcombination Vesting

The portion of the replacement awards attributable to postcombination vesting, and therefore included
in postcombination compensation cost, is calculated as follows:
Acquisition-date fair-value-based measure of the acquiree’s replaced awards

– Amount attributable to precombination vesting
Incremental fair-value-based measure of the replacement awards in excess of the replaced awards
+ as of the acquisition date (as calculated in Step 2)
= Postcombination compensation cost
404
The example below illustrates how to allocate the replacement awards between consideration
transferred and postcombination compensation cost for an employee award.
Example 10-3
Allocation of Consideration
On January 1, 20X1, Entity B grants 100 share-based payment awards to an employee that vest at the end of
the third year of service (cliff vesting).
On January 1, 20X2, Entity A acquires B in a transaction accounted for as a business combination and is
obligated to replace the employee’s awards with 100 new awards that have the same service terms as B’s
original awards (i.e., the replacement awards will vest at the end of two additional years). On January 1, 20X2,
the fair-value-based measure of both A’s replacement awards and B’s replaced awards is $10 per award.
The total fair-value-based measure of the replacement awards as of the acquisition date is $1,000 (100
awards × $10 fair-value-based measure), of which $333 (one of three years) is attributable to precombination
service and $667 (two of three years) is attributable to postcombination service. The $333 is included in the
consideration transferred, and the $667 is recognized as compensation cost by A as the service is rendered
by the employee (i.e., from January 1, 20X2, to December 31, 20X3). Note that the grant-date fair-value-based
measure assigned to the awards issued by B is not relevant as of the acquisition date.
See Section 9.6 for an example of how to allocate the replacement awards between consideration
transferred and postcombination compensation cost for a nonemployee award.
10.2.2 Forfeitures
ASC 805-30
55-11 Regardless of the accounting policy elected in accordance with paragraph 718-10-35-1D or 718-10-35-3,
the portion of a nonvested replacement award included in consideration transferred shall reflect the acquirer’s
estimate of the number of replacement awards for which the service is expected to be rendered or the goods
are expected to be delivered (that is, an acquirer that has elected an accounting policy to recognize forfeitures
as they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3 should estimate the number of
replacement awards for which the service is expected to be rendered or the goods are expected to be delivered
when determining the portion of a nonvested replacement award included in consideration transferred). For
example, if the fair-value-based measure of the portion of a replacement award attributed to precombination
vesting is $100 and the acquirer expects that the service will be rendered for only 95 percent of the instruments
awarded, the amount included in consideration transferred in the business combination is $95. Changes in the
number of replacement awards for which the service is expected to be rendered or the goods are expected to
be delivered are reflected in compensation cost for the periods in which the changes or forfeitures occur — not
as adjustments to the consideration transferred in the business combination. If an acquirer’s accounting policy
is to account for forfeitures as they occur, the amount excluded from consideration transferred (because the
service is not expected to be rendered or the goods are not expected to be delivered) should be attributed to
the postcombination vesting and recognized in compensation cost over the employee’s requisite service period
or the nonemployee’s vesting period. Recognition of compensation cost for nonemployees should consider
the recognition guidance provided in paragraph 718-10-25-2C. That is, recognition of the fair value of the
nonemployee share-based payment award should be recognized 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 awards.
forfeitures when the awards are granted and update its estimate when information becomes available
indicating that actual forfeitures will differ from previous estimates or (2) account for forfeitures when
they occur. See Section 3.4.1 for examples illustrating how to account for forfeitures under either
accounting policy election.
405
ASC 718 permits an entity to make an entity-wide policy election for all nonemployee awards to either
(1) estimate forfeitures or (2) recognize forfeitures when they occur. This policy election can be different
from the entity’s policy election for employee awards.
Regardless of the accounting policy elected for forfeitures, ASC 805-30-55-11 requires that the
portion of the fair-value-based measure of the replacement share-based payment awards included in
consideration transferred (i.e., the amount attributable to precombination vesting) reflect the acquirer’s
forfeiture estimate as of the acquisition date. If the acquirer’s accounting policy is to account for
forfeitures when they occur, the amount that is excluded from consideration transferred on the basis of
the acquirer’s estimate of forfeitures as of the acquisition date should be attributed to postcombination
vesting and recognized in compensation cost over the employee’s requisite service period or
nonemployee’s vesting period. Changes in the forfeiture estimate or actual forfeitures (i.e., an increase
or decrease in the number of awards expected to vest or awards that actually vest) are recorded in
postcombination compensation cost and not as adjustments to the consideration transferred in the
business combination. There is diversity in practice regarding how such changes should be reflected in
the financial statements (see Section 10.3).
10.2.3 Employee Awards With a Graded Vesting Schedule

ASC 805-30
55-12 Similarly, the effects of other events, such as modifications or the ultimate outcome of awards with
performance conditions, that occur after the acquisition date are accounted for in accordance with Topic
718 in determining compensation cost for the period in which an event occurs. If the replacement award for
an employee award has a graded vesting schedule, the acquirer shall recognize the related compensation
cost in accordance with its policy election for other awards with graded vesting in accordance with paragraph
718-10-35-8.
Graded vesting awards are awards that are split into multiple tranches, each of which legally and
separately vests as service is provided. For example, an entity may grant an employee 100 share-based
payment awards, 25 of which legally vest at the end of each of the four years of service provided. Under
ASC 718-10-35-8, the entity can make a policy decision about whether to recognize compensation cost
for its employee awards with only service conditions that have a graded vesting schedule on either
(1) an accelerated basis as though each separately vesting portion of the award was, in substance, a
separate award or (2) a straight-line basis over the requisite service period for the entire award (i.e.,
over the requisite service period of the last separately vesting portion of the award).2 An acquiree may
have made an accounting policy election regarding the recognition of the compensation cost for an
award with a graded vesting schedule (i.e., as a single award or as in-substance multiple awards) that
is different from the election made by the acquirer. Regardless of how the acquiree elected to account
for its replaced share-based payment awards with a graded vesting schedule, the acquirer applies
its existing accounting policy election for similar awards with a graded vesting schedule to recognize
compensation cost for the replacement awards.
2
Note that regardless of an entity’s policy decision regarding the recognition of compensation cost, it may elect to value the awards as (1) a
single award or (2) in-substance multiple awards. That is, even though each portion of the awards may directly or indirectly be treated by certain
valuation techniques as individual awards, the entity is able to make a policy decision to recognize compensation cost as (1) a single award or
(2) in-substance multiple awards.
406
This guidance is also important in the determination of the portion of the fair-value-based measure
of the replacement award that is attributable to (1) precombination service and therefore included in
consideration transferred and (2) postcombination service and therefore included in postcombination
compensation cost. The acquirer should determine its attribution of compensation cost on the basis
of its accounting policy election. If it has elected to treat an award with a graded vesting schedule as a
single award, the determination of the total service period and the original service period will be based
on a single award (e.g., a single award with four years of required service). Conversely, if it has elected
to treat an award with a graded vesting schedule as, in substance, multiple awards, the determination
of the total service period and the original service period will be based on each tranche of the award as
though the award is, in substance, multiple awards (e.g., four separate awards with required service of
one, two, three, and four years, respectively). The examples below illustrate this guidance.
Note that if the policy elections of the acquiree and the acquirer differ, on a combined basis (i.e.,
in the acquiree’s financial statements and the acquirer’s financial statements) compensation cost
(1) may not be recorded in either the acquiree’s precombination financial statements or the acquirer’s
postcombination financial statements or (2) may be recorded in both the acquiree’s precombination
financial statements and the acquirer’s postcombination financial statements. This concept is illustrated
in Example 10-5.
Example 10-4
Replacement Awards With Graded Vesting

On January 1, 20X1, Entity B grants 1,000 employee share-based payment awards. The awards vest in 25
percent increments each year over the next four years (i.e., a graded vesting schedule) and have only a service
condition. On December 31, 20X3, Entity A acquired B in a transaction accounted for as a business combination
and is obligated by the acquisition agreement to replace B’s awards with new awards that have the same
terms and conditions. (Section 10.1 discusses how to determine when an acquirer is obligated to exchange
an acquiree’s awards.) Both A and B have chosen, as their policy election, to recognize compensation cost on
a straight-line basis over the requisite service period for the entire award (i.e., as though the award is a single
award).
The fair-value-based measure of both awards (i.e., the replaced awards and the replacement awards) is $10
per award as of the acquisition date. The portion of the fair-value-based amount of the replacement award
attributable to (1) precombination service and therefore included in consideration transferred is $7,500 ($10
fair-value-based measure of the replaced award × 1,000 awards × 75% for three of four years of services
rendered) and (2) postcombination service and therefore included in postcombination compensation cost is
$2,500 ($10 fair-value-based measure of the replacement award × 1,000 awards × 25% for one of four years of
services rendered).
407
Example 10-5
Replacement Awards With Graded Vesting When the Policy Elected by the Acquirer to Recognize
Compensation Cost Is Different From the Policy Elected by the Acquiree
Assume the same facts as in the example above, except that the acquirer has elected, as a policy decision,
to recognize compensation cost over the requisite service period for each separately vesting portion of the
award (i.e., as though the award is, in substance, multiple awards). The acquirer has also made a policy election
to value such share-based payment awards as a single award. The table below summarizes the attribution of
the fair-value-based amount of the replaced awards ($10,000 = 1,000 awards × $10 fair-value-based measure
of the replaced award) over each of the first three years of service and the related amount attributable to
precombination service and therefore included in consideration transferred.
Total
Compensation Cumulative
Cost for Each Amount
Award Year 1 Year 2 Year 3 Year 4 After Year 3
Tranche 1 $ 2,500 2,500 — — $ 2,500
Tranche 2 2,500 1,250 1,250 — 2,500
Tranche 3 2,500 833 833 834 2,500
Tranche 4 2,500 625 625 625 625 1,875
Total $ 10,000 $ 9,375
The portion of the fair-value-based amount of the replacement awards attributable to (1) precombination
service and therefore included in consideration transferred is $9,375 (even though the acquiree would have
only recognized $7,500 in compensation cost because of the difference in policies) and (2) postcombination
service and therefore included in postcombination compensation cost is $625.
10.3 Changes Reflected in Postcombination Compensation Cost

ASC 805-30
Replacement Share-Based Payment Awards

35-3 Topic 718 provides guidance on subsequent measurement and accounting for the portion of replacement
share-based payment awards issued by an acquirer that is attributable to future goods or services.
408
Acquirer Share-Based Payment Awards Exchanged for Awards Held by the Grantees of the Acquiree
55-11 Regardless of the accounting policy elected in accordance with paragraph 718-10-35-1D or 718-10-
35-3, the portion of a nonvested replacement award included in consideration transferred shall reflect the
acquirer’s estimate of the number of replacement awards for which the service is expected to be rendered or
the goods are expected to be delivered (that is, an acquirer that has elected an accounting policy to recognize
forfeitures as they occur in accordance with paragraph 718-10-35-1D or 718-10-35-3 should estimate the
number of replacement awards for which the service is expected to be rendered or the goods are expected
to be delivered when determining the portion of a nonvested replacement award included in consideration
transferred). For example, if the fair-value-based measure of the portion of a replacement award attributed to
precombination vesting is $100 and the acquirer expects that the service will be rendered for only 95 percent
of the instruments awarded, the amount included in consideration transferred in the business combination is
$95. Changes in the number of replacement awards for which the service is expected to be rendered or the
goods are expected to be delivered are reflected in compensation cost for the periods in which the changes
or forfeitures occur — not as adjustments to the consideration transferred in the business combination. If an
acquirer’s accounting policy is to account for forfeitures as they occur, the amount excluded from consideration
transferred (because the service is not expected to be rendered or the goods are not expected to be
delivered) should be attributed to the postcombination vesting and recognized in compensation cost over
the employee’s requisite service period or the nonemployee’s vesting period. Recognition of compensation
cost for nonemployees should consider the recognition guidance provided in paragraph 718-10-25-2C. That
is, recognition of the fair value of the nonemployee share-based payment award should be recognized 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 awards.
55-12 Similarly, the effects of other events, such as modifications or the ultimate outcome of awards with
performance conditions, that occur after the acquisition date are accounted for in accordance with Topic
718 in determining compensation cost for the period in which an event occurs. If the replacement award for
an employee award has a graded vesting schedule, the acquirer shall recognize the related compensation
cost in accordance with its policy election for other awards with graded vesting in accordance with paragraph
718-10-35-8.
55-13 The same requirements for determining the portions of a replacement award attributable to
precombination and postcombination vesting apply regardless of whether a replacement award is classified
as a liability or an equity instrument in accordance with the provisions of paragraphs 718-10-25-6 through
25-19A. All changes in the fair-value-based measure of awards classified as liabilities after the acquisition date
and the related income tax effects are recognized in the acquirer’s postcombination financial statements in the
period(s) in which the changes occur.
10.3.1 Changes in Forfeiture Estimates or Actual Forfeitures in the

Postcombination Period
ASC 805-30-55-11 requires an acquirer to reflect changes in (1) the acquirer’s forfeiture estimate (if
the acquirer’s accounting policy is to estimate forfeitures) or (2) actual forfeitures (if the acquirer’s
accounting policy is to account for forfeitures when they occur) in the postcombination period in
compensation cost for the period in which the changes occur. If the acquirer’s accounting policy is to
account for forfeitures when they occur, it should attribute to postcombination vesting, and recognize
in compensation cost over the employee’s requisite service period or the nonemployee’s vesting period,
the amount excluded from consideration transferred (i.e., attributable to precombination vesting) on the
basis of the acquirer’s estimate of forfeitures as of the acquisition date. However, views differ on how
the acquirer should reflect changes in its forfeiture estimate or actual forfeitures (i.e., a decrease in the
number of awards expected to vest or awards that actually vest) in postcombination compensation cost.
409
The following are two acceptable views on accounting for circumstances in which the forfeiture estimate
or actual forfeitures have increased since the acquisition-date forfeiture estimate (in the event of a
decrease, only View B would apply) and the related tax implications of each view:
• View A — An increase in an acquirer’s forfeiture estimate or actual forfeitures (i.e., a decrease

in the number of awards expected to vest or that actually vest) should result in the reversal of
compensation cost associated with the acquisition-date fair-value-based measure of the awards
not expected to vest or that do not actually vest that was solely attributed to postcombination
vesting as of the acquisition date. The reversal of the corresponding deferred tax asset (DTA)
related to the acquisition-date fair-value-based measure attributed to both precombination
vesting and postcombination vesting must be recognized in the current-period income tax
provision.
• View B — An increase in the acquirer’s forfeiture estimate or actual forfeitures (i.e., a decrease
in the number of awards expected to vest or that actually vest) should result in the reversal
of compensation cost for the acquisition-date fair-value-based measure of the awards not
expected to vest or that do not actually vest, regardless of whether that measure was attributed
to precombination or postcombination vesting as of the acquisition date. This reversal of
compensation cost may exceed the amounts previously recognized as compensation cost in
the acquirer’s postcombination financial statements. In a manner similar to View A, the acquirer
must recognize in the current-period income tax provision the reversal of the corresponding
DTA related to the acquisition-date fair-value-based measure attributed to both precombination
and postcombination vesting.
An acquirer may elect either view as an accounting policy.
The examples below illustrate the accounting for an increase in the acquirer’s forfeiture estimate or
actual forfeitures under View A and View B.
Example 10-6
View A — Entity Elects to Estimate Forfeitures

On January 1, 20X1, Entity D grants employees 100 nonqualified (tax-deductible) stock options that vest at
the end of the fifth year of service (cliff vesting). On December 31, 20X4, Entity C acquires D in a transaction
accounted for as a business combination and is obligated to replace the employees’ awards with 100
replacement awards that have the same service terms as D’s original awards (i.e., the replacement awards
will vest at the end of one additional year of service). The fair-value-based measure of each award on the
acquisition date is $10. Accordingly, the fair-value-based measure of both C’s awards (the replacement
awards) and D’s awards (the replaced awards) is $1,000 as of the acquisition date. Entity C attributes $800 of
the acquisition-date fair-value-based measure of the replacement awards to precombination service and the
remaining $200 to postcombination service. The $200 attributed to the postcombination service is recognized
as postcombination compensation cost over the replacement awards’ remaining one-year service period. On
the acquisition date, C estimates that 25 percent of the replacement awards granted will be forfeited. Entity C’s
applicable tax rate is 40 percent and its policy is to estimate forfeitures.
410
Journal Entries: December 31, 20X4, Acquisition Date
Goodwill 600
APIC 600
DTA 240
Goodwill 240
To record the portion of the acquisition-date fair-value-based
measure of the replacement awards of $600 ($800 acquisition-
date fair-value-based measure allocated to precombination
service × 75% awards expected to vest) that is attributable to
precombination service, and therefore included in consideration
transferred, and the corresponding income tax effects.
Journal Entries: Quarter Ended March 31, 20X5
Compensation cost 37.50

APIC 37.50
DTA 15.00
Income tax provision 15.00
measure of the replacement awards of $37.50 ($200 acquisition-
date fair-value-based measure allocated to postcombination
service × 75% awards expected to vest × 25% of service rendered)
attributable to postcombination service, and therefore included
in postcombination compensation cost, and the corresponding
income tax effects for the first quarter of service.
Journal Entries: Quarter Ended June 30, 20X5
Compensation cost 37.50

APIC 37.50
DTA 15.00
Income tax provision 15.00
measure of the replacement awards of $37.50 [($200 acquisition-
service × 75% awards expected to vest × 50% of service
rendered) – $37.50 compensation cost previously recognized]
income tax effects for the second quarter of service.
During the third quarter, C goes through a restructuring, and many of D’s former employees terminate their
employment before their replacement awards vest. Accordingly, C changes its forfeiture estimate for the
replacement awards from 25 percent to 80 percent.
411
Journal Entries: Quarter Ended September 30, 20X5
APIC 45
Income tax provision 18

DTA 18
To record the adjustment for the increase in forfeiture estimate
in the third quarter of $45 [($200 acquisition-date fair-value-
based measure allocated to postcombination service × 20%
revised awards expected to vest × 75% of service rendered) – $75
compensation cost previously recognized] and the corresponding
income tax effects.

DTA 176
To record the reversal of $176 [($800 acquisition-date fair-value-
based measure allocated to precombination service × 20%
revised awards expected to vest × 40% tax rate) – $240 DTA
previously recognized] for the DTA related to the acquisition-date
fair-value-based measure attributed to precombination service.
There were no additional changes to the forfeiture estimate in the fourth quarter; therefore, 20 of the 100
replacement awards vested.
Journal Entries: Quarter Ended December 31, 20X5
APIC 10
DTA 4
measure of the replacement award of $10 [($200 acquisition-
service × 20% awards expected to vest × 100% of service
rendered) – $30 compensation cost previously recognized]
income tax effects for the fourth quarter of service.
412
Example 10-7
View B — Entity Elects to Estimate Forfeitures

Assume the same facts as in the example above. Under View B, there is no difference in the accounting as of
the acquisition date and for the first two quarters of service in the postcombination period (i.e., the journal
entries are the same). However, Entity C’s accounting in the third quarter for the change in forfeiture estimate
will differ from that under View A.
Because C’s forfeiture estimate has increased to 80 percent in the third quarter, only $200 of the $1,000
acquisition-date fair-value-based measure of the replacement awards should be allocated between
the precombination and postcombination service periods. Accordingly, C recognizes an adjustment in
postcombination compensation cost for the sum of (1) the amount of the acquisition-date fair-value-based
measure of the replacement awards that was originally included in consideration transferred but that is
associated with replacement awards of $440 that are no longer expected to vest — ($800 acquisition-date
fair-value-based measure allocated to precombination service × 20% revised awards expected to vest) – $600
previously recognized as consideration transferred — and (2) the amount of the acquisition-date fair-value-
based measure of the replacement awards that was originally included in postcombination compensation cost
but that is associated with replacement awards of $45 that are no longer expected to vest: ($200 acquisition-
date fair-value-based measure allocated to postcombination service × 20% revised awards expected to vest ×
75% service rendered) – $75 previously recognized as compensation cost.
With respect to the income tax adjustments, the offsetting entry for the reversal of the DTA associated with
the amount that was previously recorded in consideration transferred would be recorded in the income tax
provision along with the offsetting entry for the reversal of the DTA associated with the amount that was
previously recorded in postcombination compensation cost.
APIC 485

DTA 194
To record the adjustment for the increase in forfeiture estimate in
the third quarter of $485 [($800 acquisition-date fair-value-based
measure allocated to precombination service × 20% revised
awards expected to vest) – $600 previously recognized as
consideration transferred + ($200 acquisition-date fair-value-
based measure allocated to postcombination service × 20%
revised awards expected to vest × 75% of service rendered) – $75
compensation cost previously recognized] and the corresponding
income tax effects.
As in the example above, there were no additional changes to the forfeiture estimate in the fourth quarter;
therefore, 20 of the 100 originally issued awards vested.
413
APIC 10
DTA 4
measure of the replacement awards of $10 [($200 acquisition-
service × 20% awards expected to vest × 100% service
rendered) – $30 compensation cost previously recognized]
attributable to postcombination service and, therefore included
Example 10-8
View A — Entity Elects to Account for Forfeitures as They Occur

Assume the same facts as in Example 10-6, except that Entity C elects to account for forfeitures as they occur,
and all forfeitures (80 awards) occur in the quarter ended September 30, 20X5. Entity C is still required to
estimate the number of awards that will vest in calculating the portion of the fair-value-based measure of the
replacement awards included in consideration transferred (i.e., attributable to precombination service). In
addition, in a manner consistent with its accounting policy election, C recognizes compensation cost of $200 for
the portion of all outstanding awards attributable to postcombination service. However, C is also required to
include the amount ($200) excluded from consideration transferred (on the basis of C’s estimate of forfeitures
as of the acquisition date) as compensation cost attributed to postcombination service ($800 acquisition-date
fair-value-based measure initially allocated to precombination service × 25% awards not expected to vest).
There is no difference in the accounting as of the acquisition date (i.e., the journal entries are the same)
because C is still required to estimate forfeitures to determine the portion of the acquisition-date fair-value-
based measure of the replacement awards attributed to precombination service.

APIC 100
DTA 40
service × 25% of service rendered) + ($800 acquisition-date fair-
value-based measure initially allocated to precombination
service × 25% awards not expected to vest × 25% of service
rendered)] attributable to postcombination compensation cost
and the corresponding income tax effects for the first quarter of
service.
414

APIC 100
DTA 40
service × 50% of service rendered) + ($800 acquisition-date fair-
value-based measure initially allocated to precombination service
× 25% awards not expected to vest × 50% of service rendered) –
$100 previously recognized as compensation cost] attributable to
postcombination compensation cost and the corresponding
income tax effects for the second quarter of service.
Since C’s accounting policy is to account for forfeitures as they occur, and it was required to recognize as
compensation cost the amount excluded from consideration transferred related to its estimate of forfeitures
as of the acquisition date, it also makes an adjustment to recognize an increase in actual forfeitures related
to the amount it would have recognized as consideration transferred if the acquisition-date estimate of
forfeitures were equal to actual forfeitures. Because C’s actual forfeitures are 80 percent in the third quarter, it
should allocate only $200 of the $1,000 acquisition-date fair-value-based measure of the replacement awards
between the precombination and postcombination service periods. Accordingly, C recognizes an adjustment
in postcombination compensation cost for the sum of (1) the amount of the acquisition-date fair-value-based
measure of the replacement awards that was initially allocated to precombination service and is associated
with replacement awards of $540 that are forfeited — ($800 acquisition-date fair-value-based measure
initially allocated to precombination service × 20% of awards outstanding) – $600 previously recognized as
consideration transferred – $100 previously recognized as compensation cost for the amount excluded from
consideration transferred — and (2) the amount of the acquisition-date fair-value-based measure of the
replacement awards that was originally included in postcombination compensation cost but that is associated
with replacement awards of $70 that are now forfeited: ($200 acquisition-date fair-value-based measure
allocated to postcombination service × 20% of awards outstanding × 75% service rendered) – $100 previously
recognized as compensation cost. However, under View A, the adjustment is limited to the $100 previously
recognized as compensation cost (based on the amount excluded from consideration transferred related to
A’s estimate of forfeitures at the acquisition date). In addition, no adjustment related to the DTA previously
recorded in purchase accounting (attributable to precombination service) is recognized until the actual
forfeitures exceed the amount of forfeitures estimated as of the acquisition date.
APIC 170

DTA 68
To record the adjustment for the actual forfeitures in the third
quarter of $170 [($200 acquisition-date fair-value-based measure
allocated to postcombination service × 20% of awards
outstanding × 75% of service rendered) – $200 compensation
cost previously recognized] and the corresponding income tax
effects.
415

DTA 176
To record the reversal of $176 [($800 acquisition-date fair-value-
based measure initially allocated to precombination service ×
20% of awards outstanding × 40% tax rate) – $240 DTA previously
recognized] for the DTA related to the acquisition-date fair-
value-based measure attributed to consideration transferred (i.e.,
precombination service).
Because all the forfeitures occurred in the third quarter, there are no additional adjustments, and 20 of the 100
replacement awards vested.
APIC 10
DTA 4
service × 20% of awards vested × 100% of service rendered)
– $30 previously recognized as compensation cost] attributable
to postcombination service, and therefore included in
postcombination compensation cost, and the corresponding
Example 10-9
View B — Entity Elects to Account for Forfeitures as They Occur

Assume the same facts as in the previous example. Under View B, there is no difference in the accounting as
of the acquisition date and for the first two quarters of service in the postcombination period (i.e., the journal
entries are the same). However, Entity C’s accounting in the third quarter for the change in actual forfeitures
will differ from the accounting under View A because the adjustment is not limited to the amount previously
recognized as compensation cost.
APIC 610

DTA 244
To record the adjustment of $610 ($540 + $70) for the increase
in actual forfeitures in the third quarter and the corresponding
income tax effects.
As in the previous example, because all the forfeitures occurred in the third quarter, there are no additional
adjustments, and 20 of the 100 replacement awards vested.
416
APIC 10
DTA 4
service × 20% of awards vested × 100% of service rendered)
– $30 previously recognized as compensation cost] attributable
to postcombination service, and therefore included in
postcombination compensation cost, and the corresponding
10.3.2 Changes in the Probability of Meeting a Performance Condition in the

Postcombination Period
ASC 805-30-55-12 states that the effects of the ultimate outcome of awards with performance
conditions that occur after the acquisition date should be accounted for in accordance with ASC 718 in
the period that the event occurs. However, views differ on how an acquirer should reflect a change in
the expected outcome of a performance condition that results in a decrease in the number of awards
expected to vest (e.g., a performance condition that was deemed probable as of the acquisition date
that is subsequently considered improbable) in postcombination compensation cost.
The following are two acceptable views on accounting for circumstances in which the achievement of a
performance condition is deemed probable as of the acquisition date and is subsequently considered
improbable (if achievement of a performance condition is deemed improbable as of the acquisition date
and subsequently becomes probable, only View B would apply):
• View A — A change in the expected outcome of a performance condition from probable to

improbable should result in the reversal of compensation cost associated with the acquisition-
date fair-value-based measure that was solely attributed to postcombination vesting as of the
acquisition date. The reversal of the corresponding DTA related to the acquisition-date fair-
value-based measure attributed to both precombination and postcombination vesting must be
recognized in the current-period income tax provision.
• View B — A change in the expected outcome of a performance condition from probable to

improbable should result in the reversal of compensation cost for the acquisition-date fair-
value-based measure of all awards not expected to vest, regardless of whether that acquisition-
date fair-value-based measure was attributed to precombination or postcombination vesting as
of the acquisition date. This reversal of compensation cost may exceed the amounts previously
recognized as compensation cost in the acquirer’s postcombination financial statements. In a
manner similar to View A, the reversal of the corresponding DTA related to the acquisition-date
fair-value-based measure attributed to both the precombination and postcombination vesting
must be recognized in the current-period income tax provision.
An acquirer may elect either view as an accounting policy.
417
The examples below illustrate the accounting for a change in the expected outcome of a performance
condition from probable to improbable under View A and View B.
Example 10-10
View A
On January 1, 20X1, Entity D grants employees 100 nonqualified (tax-deductible) stock options that vest only
if D’s cumulative net income over the succeeding five years is greater than $5 million. On the grant date, it is
deemed probable that the performance condition will be met. Accordingly, D begins to recognize compensation
cost on a straight-line basis over the five-year service period.
On December 31, 20X4, Entity C acquires D in a transaction accounted for as a business combination and is
obligated to replace the employees’ awards with 100 new awards that have the same terms as D’s original
awards (i.e., the replacement awards will vest at the end of one additional year of service if the performance
condition is met). The fair-value-based measure of each award on the acquisition date is $10. Accordingly, the
fair-value-based measure of both C’s awards (the replacement awards) and D’s awards (the replaced awards) is
$1,000 as of the acquisition date.
Entity C attributes $800 of the acquisition-date fair-value-based measure of the replacement awards to
precombination service and the remaining $200 to postcombination service. The $200 attributed to the
postcombination service is recognized as postcombination compensation cost over the replacement awards’
remaining one-year service period. On the acquisition date, it is still probable that the performance condition
will be met. Assume that C’s applicable tax rate is 40 percent.
Journal Entries: December 31, 20X4, Acquisition Date
Goodwill 800
APIC 800
DTA 320
Goodwill 320
measure of the replacement awards attributable to
precombination service, and therefore included in consideration
transferred, and the corresponding income tax effects.
APIC 50
DTA 20
measure of the replacement awards of $50 ($200 acquisition-date
fair-value-based measure allocated to postcombination service ×
25% of service rendered) attributable to postcombination service,
and therefore included in postcombination compensation cost,
and the corresponding income tax effects for the first quarter of
service.
418
APIC 50
DTA 20
service × 50% of service rendered) – $50 compensation cost
previously recognized] attributable to postcombination service,
and therefore included in postcombination compensation cost,
and the corresponding income tax effects for the second quarter
of service.
During the third quarter, C loses one of its largest customers and no longer believes that meeting the
performance condition is probable.
APIC 100

DTA 40
To record an adjustment for the change in the expected outcome
of the performance condition from probable to improbable in the
third quarter of $100 (compensation cost previously recognized)
and the corresponding income tax effects.

DTA 320
To record the reversal of $320 ($800 acquisition-date fair-value-
based measure allocated to precombination service × 40% tax
rate) for the DTA related to the acquisition-date fair-value-based
measure attributed to precombination service.
Entity C ultimately did not meet the performance condition. Therefore, none of the awards vested, and no
additional journal entries were necessary.
419
Example 10-11
View B
Assume all the same facts as in the example above. Under View B, there is no difference in the accounting as
of the acquisition date and for the first two quarters of service in the postcombination period (i.e., the journal
entries are the same). However, Entity C’s accounting in the third quarter for the change in the expected
outcome of the performance condition from probable to improbable will differ from its accounting under View A.
Because C has now determined that meeting the performance condition is no longer probable, it recognizes
an adjustment to postcombination compensation cost for the sum of (1) the amount of the acquisition-date
fair-value-based measure of the replacement awards that was originally included in consideration transferred
but that is associated with replacement awards of $800 that are no longer expected to vest and (2) the amount
of the acquisition-date fair-value-based measure of the replacement awards that was originally included in
postcombination compensation cost but that is associated with replacement awards of $100 that are no longer
expected to vest ($200 acquisition-date fair-value-based measure allocated to postcombination service × 50%
of service rendered).
With respect to the income tax adjustments, the offsetting entry for the reversal of the DTA associated with
the amount that was previously recorded in consideration transferred would be recorded in the income tax
provision along with the offsetting entry for the reversal of the DTA associated with the amount that was
previously recorded in postcombination compensation cost.
APIC 900

DTA 360
To record an adjustment for the change in the expected outcome
of the performance condition from probable to improbable in
the third quarter of $900 ($800 acquisition-date fair-value-based
measure allocated to precombination service + $100
compensation cost previously recognized) and the corresponding
income tax effects.
As in the example above, C ultimately did not meet the performance condition. Therefore, none of the awards
vested, and no additional journal entries were necessary.
10.4 Acceleration of Vesting Upon a Change in Control

The accounting for the accelerated vesting of an award upon a change in control will depend on which
party initiated the acceleration as well as on whether the acceleration is a preexisting provision in the
terms of the acquiree’s awards.
10.4.1 Acquirer Accelerates Vesting

An acquirer’s decision to immediately vest or reduce the future vesting period of awards held by
grantees of the acquiree does not affect the portion of the fair-value-based measure of the replacement
awards that is attributable to postcombination vesting and therefore included in postcombination
compensation cost; rather, it affects the timing of the recognition of postcombination compensation
cost. This is because the allocation of compensation expense to precombination and postcombination
periods is based on the greater of (1) the total vesting period or (2) the original vesting period of the
replaced awards (see Section 10.2.1.3). Therefore, in instances in which the acquirer accelerates vesting,
the allocation will still be based on the original vesting period of the replaced awards. For example, if
420
the acquirer decides to immediately vest the replacement awards, the portion of the fair-value-based
measure of the awards attributable to postcombination vesting would be immediately recognized
as compensation cost in the acquirer’s postcombination financial statements. The amount of the
compensation cost would not be affected.
Example 10-12
Acquirer Accelerates Vesting Upon the Acquisition Date

On January 1, 20X1, Entity B issues 100 share-based payment awards to an employee that vest at the end
of the third year of service (cliff vesting). On January 1, 20X2, Entity A acquires B in a transaction accounted
for as a business combination and is obligated to replace the employee’s awards with 100 new awards that
have the same service terms as B’s original awards. On January 1, 20X2, the fair-value-based measure of both
A’s replacement awards and B’s replaced awards is $10 per award. Entity A then immediately vests all of the
outstanding replacement awards on the date of the business combination.
The total fair-value-based measure of the replacement awards as of the acquisition date is $1,000 (100
awards × $10 fair-value-based measure), of which $333 (one of three years) is attributable to precombination
service and $667 (two of three years) is attributable to postcombination service. The $333 is included in the
consideration transferred, and the $667 is recognized as compensation cost by A in the postcombination
financial statements immediately upon the business combination.
If the fair-value-based measure of the replacement awards had been greater than the acquisition-date
fair-value-based measure of B’s replaced awards, any excess would have been recognized immediately as
compensation cost in A’s postcombination financial statements.
10.4.2 Acceleration of Vesting Included in the Original Terms of the Awards

If share-based payment awards of the acquiree become immediately vested on the date of the business
combination because of a preexisting provision in the awards’ terms that accelerates their vesting
(commonly referred to as a “change-in-control” provision), the portion of the replacement awards
that is attributable to precombination vesting and therefore included in consideration transferred
would be affected. As noted in Section 10.2, the portion of the replacement awards attributable to
precombination vesting is the acquisition-date fair-value-based measure of the replaced awards
multiplied by the ratio of the precombination vesting period to the greater of the (1) total vesting
period or (2) original vesting period of the replaced awards. Since (1) all of the goods or services have
been provided in the precombination period, (2) there is no requirement for future vesting, and (3) the
original vesting period is complete, the entire fair-value-based measure of the replaced awards
would be attributable to precombination vesting and therefore included in consideration transferred.
If the fair-value-based measure of the replacement awards is the same as that of the replaced awards,
there is no postcombination compensation cost recognized. If, however, the fair-value-based measure
of the replacement awards is greater than that of the replaced awards, the excess is recognized as
postcombination compensation cost.
Note that there is diversity in practice related to the acquiree’s recognition of the remaining
unrecognized compensation cost. One view is that any remaining unrecognized compensation cost
associated with the original grant-date fair-value-based measure of the awards should be recognized
in the acquiree’s precombination financial statements. Alternatively, the compensation cost may be
presented in neither the acquiree’s precombination financial statements nor the combined entity’s
postcombination financial statements (i.e., it is recognized on the “black line”). See Section A.17.1 of
Deloitte’s Roadmap Business Combinations for information about the presentation of certain acquiree
expenses triggered by the consummation of a business combination.
421
Example 10-13
Acceleration of Vesting Included in the Original Terms of the Award

Assume the same facts as in Example 10-12, except that the original terms of Entity B’s awards included a
preexisting provision that accelerates their vesting upon B’s acquisition. Since (1) all of the service has been
rendered in the precombination period, (2) there is no requirement for future service, and (3) the original
service period is complete, the entire $1,000 would be attributable to precombination service and therefore
included in consideration transferred.
10.4.3 Modification to the Original Terms of the Awards to Add a Change-in-

Control Provision in Contemplation of a Business Combination
In some instances, share-based payment awards are modified to add a change-in-control provision
in contemplation of a business combination. A modification could also result from the decision to
exercise a discretionary change-in-control provision that was part of the original terms of the award
(or was added in contemplation of the business combination). Such modifications may be initiated
by the acquiree or requested by the acquirer. As discussed in Section 10.2, entities should carefully
analyze a modification to determine whether it is part of, or separate from, the business combination. A
transaction that is entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer
or the combined entity is likely to be a separate transaction.
Factors for entities to consider in determining whether a transaction primarily benefits the acquirer or
the acquiree include the reason for the transaction, which party initiated it, and when it occurred, as
noted in ASC 805-10-55-18. Understanding the business purpose of a modification will help an acquirer
assess which party benefits from it. Generally, a modification to an award’s original terms to add a
change-in-control provision in contemplation of a business combination, or to exercise a discretionary
change-in-control provision, is presumed to benefit the acquirer. When a modification to accelerate the
vesting of awards upon a change in control is made at the request of the acquirer, the modification is
accounted for in accordance with ASC 718 (i.e., compensation cost is recognized over the remaining
portion of the modified requisite service period. If the award was accelerated to vest immediately upon
the change in control, the compensation cost is recognized immediately in the postcombination financial
statements (i.e., on day 1). See Section 6.3.6.1.
If the modification is for the benefit of the acquirer, the acceleration of vesting would be considered a
transaction that is separate from the business combination upon the consummation of the business
combination. Accordingly, any remaining unrecognized compensation cost associated with the
modified award would not be recognized as compensation cost in the acquiree’s precombination
financial statements. In addition, the acceleration of vesting would be accounted for as though the
acquirer had decided to accelerate the vesting of the replacement awards immediately upon the
acquisition. That is, the acquirer’s decision to accelerate the vesting of the awards would affect
the timing of the recognition of postcombination compensation cost (it would be recognized
immediately in the acquirer’s postcombination financial statements). However, it would not affect
the determination of the portion of the awards that is attributable to (1) precombination vesting and
therefore included in the consideration transferred and (2) postcombination vesting and therefore
included in postcombination compensation cost.
422
Example 10-14
Modification to Add a Change-in-Control Provision

Assume the same facts as in Example 10-12, except that to retain the employee until at least the acquisition
date, Entity B modified the employee’s existing awards during the negotiations of the business combination so
that they automatically vest upon a change in control. It was also determined that the modification was made
to benefit Entity A. The modification is therefore, in substance, the acceleration of the vesting of the awards by
the acquirer and is accounted for as a transaction that is separate from the business combination.
This accounting treatment is the same as that in Example 10-12; that is, one-third of the awards are
attributable to precombination service and two-thirds are attributable to postcombination service (which
is immediately recognized). As indicated above, acceleration of the vesting of awards by the acquirer does
not affect the portion of the fair-value-based measure of the replacement awards that is attributable to
postcombination service and therefore included in postcombination compensation cost (i.e., the $667); rather,
it affects the timing of the recognition of postcombination compensation cost (i.e., immediate).
Example 10-14A
Modification as a Result of Exercising a Discretionary Change-in-Control Provision

Assume the same facts as in Example 10-12, except that the original awards included a discretionary change-
in-control provision that allowed Entity B to elect whether upon a change in control the awards would (1) be
replaced or (2) vest in full (i.e., accelerated vesting). Entity B elected to accelerate vesting, and it was also
determined that the exercise of the discretionary provision was made to benefit Entity A.
As in Example 10-12 and the example above, the modification is, in substance, the acceleration of the vesting
of the awards by the acquirer and is accounted for as a transaction that is separate from the business
combination. The amount attributable to (1) precombination service (i.e., included in consideration transferred)
and (2) postcombination service (i.e., recognized as postcombination compensation cost by the acquirer) is
determined in a manner consistent with that described in Example 10-12 and the example above.
10.5 Cash Settlement Upon a Change in Control

In some business combinations, acquirers may, upon a change in control, cash settle share-based
payment awards instead of either accelerating the awards’ vesting provisions or replacing the awards.
Like vesting provisions that are accelerated upon a change in control (see Section 10.4), cash settlement
provisions should be analyzed carefully in the determination of whether they are part of, or separate
from, the business combination. ASC 805-10-25-20 states, in part, that the “acquirer shall recognize as
part of applying the acquisition method only the consideration transferred for the acquiree and the
assets acquired and liabilities assumed in the exchange for the acquiree. Separate transactions shall be
accounted for in accordance with the relevant [GAAP].” In addition, ASC 805-10-25-21 states, in part, that
a “transaction entered into by or on behalf of the acquirer or primarily for the benefit of the acquirer or
the combined entity, rather than primarily for the benefit of the acquiree (or its former owners) before
the combination, is likely to be a separate transaction.” As noted in Section 10.2, ASC 805-10-55-18 also
provides three factors to help entities determine whether the transaction primarily benefits the acquirer
or the acquiree (i.e., “[t]he reasons for the transaction,” “[w]ho initiated the transaction,” and “[t]he timing
of the transaction”).
423
10.5.1 Acquirer Cash Settles the Acquiree’s Awards (Cash-Settlement

Provision Is Not Included in the Original Terms of the Award)
If there is no preexisting change-in-control cash settlement provision in the original awards’ terms (but
there is a preexisting change-in-control provision under which the acquirer must issue replacement
awards) and the acquirer decides to cash settle the acquiree’s awards, the cash settlement is treated
in the same manner as if the acquirer was required to replace the awards with share-based payment
awards of the acquirer.
An acquirer’s decision to cash settle the acquiree’s share-based payment awards does not affect the
portion of the fair-value-based measure of the replacement awards (i.e., cash) that is attributable to
postcombination vesting and therefore included in postcombination compensation cost; rather, it affects
the timing of the recognition of postcombination compensation cost (i.e., if the acquiree’s awards were
previously unvested, the cash settlement would effectively accelerate vesting such that postcombination
compensation cost would be recognized immediately). Further, cash settlement does not affect the
classification of the acquiree’s replaced awards.
10.5.1.1 Fully Vested Awards That Are Cash Settled Upon a Change in Control
If awards are fully vested as of the date of the acquisition, the entire fair-value-based measure of
the acquiree’s replaced award is attributable to precombination vesting and therefore included in
consideration transferred. If the cash paid to settle fully vested awards exceeds the fair-value-based
measure of those awards, the excess over the fair-value-based measure would be immediately
recognized as compensation cost in the acquirer’s postcombination financial statements.
10.5.1.2 Partially Vested Awards That Are Cash Settled Upon a Change in Control
If awards are partially vested as of the date of acquisition, the acquirer has effectively accelerated the
vesting of the unvested portion of the award and settled the entire award. The amount of the fair-value-
based measure of the acquiree’s replaced award attributable to precombination vesting and therefore
included in consideration transferred is based on the ratio of precombination vesting to the original
vesting period of the acquiree’s replaced award (see Section 10.2.1.3.1). The amount recognized as
compensation cost in the postcombination financial statements represents (1) any excess of the cash
settlement over the fair-value-based measure of the vested replaced awards plus (2) the portion of the
fair-value-based measure attributable to the postcombination period.
10.5.2 Cash-Settlement Provision Is Included in the Original Terms of the

Award
In some circumstances, an acquiree’s share-based payment awards must be cash settled as a result of a
change in control because of a preexisting provision in the awards’ terms.
In such a case, as long as all other criteria for equity classification have been met, the awards would
be classified as equity until it becomes probable that the change in control will occur (i.e., when it
is probable that the awards will be cash settled). A change in control is generally not considered
probable until the event has occurred (i.e., when the business combination has been consummated).
424
Contemporaneously with the closing of the business combination (when it is probable that the awards will
be cash settled), the awards will become a share-based liability. As a result of the change in the probable
settlement outcome, an entity would account for the awards in accordance with ASC 718-10-35-15; that
is, the entity would account for them in a manner similar to a modification from equity awards to liability
awards (see Section 6.8.1 for a discussion and examples of the accounting for the modification of awards
whose classification changes from equity to liability. The now liability-classified awards are treated as
assumed liabilities by the acquirer in the business combination.
There is diversity in practice related to the acquiree’s recognition of the associated compensation cost
resulting from the modification. One acceptable view is that all of the acquiree’s acquisition expenses,
even those that are contingent on a change in control, should be recognized in the period in which they
were incurred. Another acceptable view is that the compensation costs should not be recognized in the
acquiree’s financial statements but instead recognized on the “black line.”3
10.5.2.1 Fully Vested Awards That Are Cash Settled Upon a Change in Control
If the awards are fully vested as of the date of acquisition, the acquirer recognizes a share-based liability
for their fair-value-based measure on the date of the acquisition. If the fair-value-based measure of
the share-based liability is greater than the original grant-date fair-value-based measure of the equity
awards, the difference is recognized as additional compensation cost in the acquiree’s precombination
financial statements or on the “black line.”4 Conversely, if the fair-value-based measure of the share-
based liability is less than or equal to the original grant-date fair-value-based measure of the equity
awards, the offsetting amount is recorded to APIC in the acquiree’s precombination financial statements.
Example 10-15
Fully Vested Awards That Are Cash Settled Upon a Change in Control
On January 1, 20X1, Entity B issues 1,000 share-based payment awards to its employees, each with a grant-
date fair-value-based measure of $5, that vest at the end of the third year of service (cliff vesting). The awards
contain a provision that requires cash settlement in the event of a change in control. Because a change in
control is generally not considered probable until it occurs, B classifies the awards as equity (as long as all other
criteria for equity classification are met).
On January 1, 20X5, Entity A acquires B in a transaction accounted for as a business combination. On January 1,
20X5, the fair-value-based measure of B’s awards is $6 per award.
Contemporaneously with the closing of the business combination, B (1) reclassifies the amount currently
residing in APIC as a share-based liability (i.e., $5,000, or 1,000 awards × $5 grant-date fair-value-based
measure × 100% of service rendered) and (2) records the excess $1,000, or ($6 acquisition-date fair-value-
based measure – $5 grant-date fair-value-based measure) × 1,000 awards × 100% of service rendered, as
additional compensation cost in the acquiree’s precombination financial statements to record the share-based
liability at its fair-value-based measure, with a corresponding adjustment to the share-based liability.
10.5.2.2 Partially Vested Awards That Are Cash Settled Upon a Change in Control
If the awards are partially vested as of the date of acquisition, the preexisting cash settlement provision
may immediately cause the awards to be vested. Accordingly, any unrecognized compensation cost
associated with the original equity awards is recognized as compensation cost in the acquiree’s
precombination financial statements or on the “black line.”5 Since the awards are now fully vested, if
the fair-value-based measure is greater than the awards’ original grant-date fair-value-based measure,
3
See Section A.17.1 of Deloitte’s Roadmap Business Combinations for information about the presentation of certain acquiree expenses triggered by
the consummation of a business combination.
4
See footnote 3.
5
See footnote 3.
425
the difference is recognized as additional compensation cost in the acquiree’s precombination financial
statements or on the black line. Conversely, if the fair-value-based measure is less than the awards’
original grant-date fair-value-based measure, the offsetting amount is recorded to APIC in the acquiree’s
precombination financial statements. In addition, the acquirer recognizes a share-based liability for the
awards’ fair-value-based measure on the date of the acquisition (i.e., generally for the amount of cash
that it expects would settle the acquiree’s awards).
Example 10-16
Partially Vested Awards That Are Cash Settled Upon a Change in Control
Assume the same facts as in Example 10-15, except that the awards granted by Entity B vest at the end of the
fifth year of service (cliff vesting) and cash settlement is required even if the awards are unvested.
Contemporaneously with the closing of the business combination, B (1) recognizes $1,000 (1,000 awards ×
$5 grant-date fair-value-based measure × 1 of 5 years of service remaining) for the remaining unrecognized
compensation cost associated with the original equity award because the cash settlement provision
immediately vests the award; (2) reclassifies the amount now residing in APIC as a share-based liability (i.e.,
$5,000, or 1,000 awards × $5 grant-date fair-value-based measure × 100% of service rendered); and (3) records
the excess $1,000, or ($6 acquisition-date fair-value-based measure – $5 grant-date fair-value-based measure)
× 1,000 awards × 100% of service rendered, as additional compensation cost in the acquiree’s precombination
financial statements to record the share-based liability at its fair-value-based measure, with a corresponding
adjustment to the share-based liability.
10.6 Arrangements for Contingent Payments to Employees or Selling

Shareholders
During negotiations of a business combination, an acquirer may agree to make a payment at some point
in the future to one or more selling shareholders or to acquiree employees who become employees
of the combined entity (or otherwise provide goods or services to the combined entity) after the
acquisition date. For example, payments to selling shareholders may be contingent on the employment
of a different selling shareholder or an acquiree’s employee after the acquisition date. There may
also be circumstances in which one or more of the selling shareholders decide to share some of
the proceeds that they are entitled to receive with one or more of the acquiree’s nonshareholder
employees. Payments made by selling shareholders to such nonshareholder employees that become
employees of the acquirer should be carefully evaluated under SAB Topic 5.T (which refers to ASC
718-10-15-4, included in Section 2.5), which discusses payments made by economic interest holders
(e.g., selling shareholders) on behalf of an entity. Acquirers must evaluate conditional future payments
(i.e., payments that include conditions other than the passage of time) to former shareholders of the
acquiree and to individuals who become employees of the combined entity (or otherwise provide goods
or services to the combined entity) to determine whether such payments represent (1) consideration
transferred (i.e., contingent consideration) or (2) compensation cost that is separate from the business
combination.
See Deloitte’s Roadmap Business Combinations for additional guidance on contingent consideration.
426
10.7 Compensation Arrangements
An acquiree in a business combination may have agreements in place to provide specified employees
with additional compensation predicated upon a change in control of the acquiree. Such arrangements
could have been established either before or after the negotiations began for the business combination.
When determining whether the acquirer should account for these arrangements as part of the business
combination or separately as compensation, entities must use judgment and consider the specific facts
and circumstances as discussed below and in Section 10.2. However, if a business combination results
in additional compensation arrangements payable to the acquirer’s employees, these payments are
always accounted for as compensation costs in the acquirer’s financial statements.
10.7.1 Arrangements to Pay an Acquiree’s Employee Upon a Change in

Control
Arrangements may be established with the objective of retaining one or more of the acquiree’s employees
until the acquisition date and possibly for a defined period thereafter. Such arrangements — often
referred to in practice as “stay bonuses,” “change in control payments,” or “golden parachutes” — may also
provide additional compensation for performance related to the business combination or compensate
employees who are terminated after the combination. An entity should account for these arrangements
on the basis of their substance. In assessing the substance of an arrangement, an entity should consider
the factors listed in ASC 805-10-55-18 (i.e., “[t]he reasons for the transaction,” “[w]ho initiated the
transaction,” and “[t]he timing of the transaction”), as presented in Section 10.2.
ASC 805-10-55-34 through 55-36 provide an example of a contingent payment to an acquiree’s employee:
ASC 805-10
Example 4: Arrangement for Contingent Payment to an Employee

55-34 This Example illustrates the guidance in paragraphs 805-10-55-24 through 55-25 relating to contingent
payments to employees in a business combination. Target hired a candidate as its new chief executive officer
under a 10-year contract. The contract required Target to pay the candidate $5 million if Target is acquired
before the contract expires. Acquirer acquires Target eight years later. The chief executive officer was still
employed at the acquisition date and will receive the additional payment under the existing contract.
55-35 In this Example, Target entered into the employment agreement before the negotiations of the
combination began, and the purpose of the agreement was to obtain the services of the chief executive
officer. Thus, there is no evidence that the agreement was arranged primarily to provide benefits to Acquirer
or the combined entity. Therefore, the liability to pay $5 million is included in the application of the acquisition
method.
55-36 In other circumstances, Target might enter into a similar agreement with the chief executive officer at the
suggestion of Acquirer during the negotiations for the business combination. If so, the primary purpose of the
agreement might be to provide severance pay to the chief executive officer, and the agreement may primarily
benefit Acquirer or the combined entity rather than Target or its former owners. In that situation, Acquirer
accounts for the liability to pay the chief executive officer in its postcombination financial statements separately
from application of the acquisition method.
If arrangements to pay an acquiree’s employees upon a change in control are determined to be part of
the business combination and are settled in equity on the acquisition date, the equity issued represents
consideration transferred in the business combination as if the acquiree’s employees had become
owners of (or increased their ownership in) the acquiree as a result of the arrangement.
427
If arrangements to pay an acquiree’s employees upon a change in control are determined to be part of
the business combination and are to be settled in cash after the acquisition date, the acquirer accounts
for the amount due as a liability assumed in the business combination, as described in Section 10.5.2.
Sometimes, the acquirer settles the arrangement by making a cash payment simultaneously with
the close of the acquisition. In determining whether to present the amount paid as consideration
transferred or as an assumed liability, an entity should use judgment and consider all relevant facts and
circumstances when applying the guidance in ASC 805-10-55-18.
Arrangements to pay an acquiree’s employees upon a change in control that are determined to be
separate from the business combination represent compensation cost of the acquirer. If no future
service is required, the acquirer should recognize compensation cost on the acquisition date.
10.7.2 Dual- or Double-Trigger Arrangements

An employment agreement entered into before negotiations began for the business combination may
include terms that require a payment or accelerate vesting upon (1) a change of control and (2) a second
defined event or “trigger,” which is why such provisions are commonly called “dual trigger” or “double
trigger” arrangements. The second defined event is generally the separation of the employee from
the acquirer and might be limited to involuntary terminations or might also include resignation of the
employee in specified conditions (sometimes referred to as “good reasons”) such as:
• A demotion or significant reduction in the employee’s duties or responsibilities after the

acquisition date.
• A significant reduction in the employee’s salary or compensation after the acquisition date.
• The relocation of the employee’s job site beyond a specified radius after the acquisition date.
The objective of such employment agreements, which are typically entered into before negotiations
have begun for a business combination, is generally to obtain the employee’s services. While the three
factors in ASC 805-10-55-18 (i.e., “[t]he reasons for the transaction,” “[w]ho initiated the transaction,” and
“[t]he timing of the transaction”) might indicate that the payments should be accounted for as part of
the business combination, such arrangements are generally accounted for separately from the business
combination. This is because the decision to effect the second trigger (i.e., the employee’s involuntary
termination or voluntary termination for “good reason”) is under the control of the acquirer and is
therefore presumed to be made primarily for the acquirer’s benefit (e.g., to reduce cost by eliminating
the unneeded employee).
Example 10-17
Dual- or Double-Trigger Arrangement Involving the Termination of Employment

Company A acquires Company B in a transaction accounted for as a business combination. Company B
has an existing employment agreement with its CEO that was put in place before negotiations began for
the combination. Under the agreement, all of the CEO’s unvested awards will fully vest upon (1) a change
in the control of B and (2) the involuntary termination of the CEO’s employment within one year after the
acquisition date.
Before the closing, A determines that it will not offer employment to the CEO after the combination has been
completed. Thus, both conditions are triggered, and the vesting of the CEO’s awards is accelerated upon the
closing of the acquisition.
The decision not to employ B’s former CEO was under A’s control and was made for A’s benefit (i.e., to reduce
costs). Therefore, A should recognize the compensation cost related to the accelerated vesting of the awards in
its postcombination financial statements and not as part of the business combination.
428
Example 10-18
Dual- or Double-Trigger Arrangement in Which Employee Resigns for “Good Reason”

As in the example above, Company A acquires Company B in a transaction accounted for as a business
combination, and B has an existing employment agreement with its CEO. However, in this example, the
agreement provides that all of the CEO’s unvested awards will fully vest upon (1) a change in the control
of B and (2) either the involuntary termination of the CEO or the voluntary departure of the CEO for “good
reason” within one year after the acquisition date. The agreement specifies that a significant reduction in job
responsibilities would be a good reason. After the acquisition date, B’s CEO will not assume the role of CEO of
the combined entity but instead will be assigned a position with reduced responsibilities. In response, B’s CEO
will resign upon the change in control.
The decision to reduce the responsibilities of B’s former CEO after the acquisition date is within A’s control.
Therefore, A should recognize the compensation cost related to the accelerated vesting of the awards in its
postcombination financial statements and not as part of the business combination.
10.7.3 Arrangements to Reallocate Forfeited Awards or Amounts to

Remaining Shareholders/Employees
An acquirer may issue share-based payment awards to a group of shareholders of the acquiree, all
of whom become employees of the combined entity with such awards subject to vesting based on
continued employment. The awards may be placed in a trust by the acquirer on the acquisition date.
Such arrangements are sometimes referred to as “last man standing” arrangements if any forfeited
awards must be reallocated to the remaining participants in the group. Some arrangements may not
specify what happens if none of the participants are still employed by the acquirer at the end of the
term; however, since these arrangements typically encompass many employees, it would be unlikely
that none remain. Other arrangements may specify that the amounts revert to the acquiree’s former
shareholders if none of the participants are still employed at the end of the term.
In his remarks at the 2000 AICPA Conference on Current SEC Developments, then SEC OCA Professional
Accounting Fellow R. Scott Blackley provided the following example of such an arrangement:
For illustration, consider an example business combination where a company acquires another enterprise,
XYZ Company, for cash and stock. All of the shareholders of XYZ Company are also employees. The acquiring
company expects and desires to have the employee shareholders of XYZ Company continue as employees of
the combined companies. Accordingly, of the shares issued to the shareholders of XYZ Company, a portion is
held in an irrevocable trust, subject to a three year vesting requirement (“forfeiture shares”).
The forfeiture provision requires that if, prior to vesting, a shareholder resigns from employment or is
terminated for cause, the shares held in the trust allocable to the employee shareholder be forfeited.
Additionally, any shares actually forfeited are reallocated to the remaining employee shareholders based on
their remaining ownership interests such that all of the forfeiture shares in the trust will ultimately be issued.
Mr. Blackley said that in this scenario, the SEC staff concluded that “the forfeiture shares must be
accounted for as a compensation arrangement.” He noted that the staff placed “significant weight” on
the shares’ vesting on the basis of continued employment even though the amount of consideration was
fixed because it would not be returned to the acquirer under any circumstances. Although Mr. Blackley
made these remarks before FASB Statement 141(R), as codified in ASC 805, was issued, we believe that
they remain relevant.
429
Therefore, in an arrangement in which share-based payment awards are issued to a group of

shareholders of the acquiree, all of whom become employees of the combined entity on the basis of a
requirement to continue employment, the forfeiture and subsequent redistribution of the awards are
accounted for as (1) the forfeiture of the original award and (2) the grant of a new award. That is, the
acquirer would reverse any compensation previously recognized for the forfeited award (on the basis of
the original grant-date fair-value-based measure) and then recognize compensation for the new award
(on the basis of the fair-value-based measure on the date the award is redistributed) over the remaining
requisite service period.
Example 10-19
Arrangement to Reallocate Forfeited Awards to Remaining Shareholders/Employees

On January 1, 20X1, Company A acquires Company B and, as part of the acquisition agreement, grants each
of B’s 10 shareholders/employees 100 new share-based payment awards that vest at the end of five years of
service (cliff vesting). The grant-date fair-value-based measure of each award as of the acquisition date is $10.
The terms of the award state that if employment is terminated before the end of five years (i.e., the vesting
date), the employee’s awards are forfeited and redistributed among the remaining employees within the group.
The total grant-date fair-value-based measure of the awards as of the acquisition date is $10,000
(10 employees × 100 awards × $10 grant-date fair-value-based measure), which A recognizes in the
postcombination financial statements as compensation cost over the five-year service period ($2,000 per year).
On December 31, 20X3, two employees in the group terminate their employment and forfeit their awards,
which are then redistributed to the eight remaining group members. The fair-value-based measure of each
redistributed (i.e., new) award is $12 on the date the awards are redistributed.
On December 31, 20X3, A should reverse $1,200 of previously recognized compensation cost (2 employees × 100
awards × $10 grant-date fair-value-based measure × 60% for 3 out of 5 years of services rendered) corresponding
to the forfeited awards. Company A should continue to recognize $1,600 in annual compensation cost (8
employees × 100 awards × $10 grant-date fair value ÷ 5 years) over each of the remaining two years of service
for the original awards provided to the remaining employees. In addition, A should recognize $1,200 in additional
annual compensation cost (200 awards × $12 grant-date fair-value-based measure ÷ 2 years of remaining service)
over each of the remaining two years of service for the redistributed awards.
In some cases, payments to the shareholders/employees may be made in cash rather than forfeitable
shares. We do not believe that the form of the payment affects the conclusion that such arrangements
are based on continued employment and therefore should be accounted for as compensation and not
as part of the exchange for the acquiree.
10.8 Tax Effects of Replacement Awards Issued in a Business Combination

See Chapter 11 of Deloitte’s Roadmap Income Taxes, which contains guidance on the accounting for the
tax effects of replacement awards issued in a business combination.
430
Chapter 11 — Income Tax Accounting
ASC 718-740 discusses the accounting for income taxes associated with share-based payment awards.
ASC 718-740-25-2 states, in part, that the “cumulative amount of compensation cost recognized for
[awards] that ordinarily would result in a future tax deduction under existing tax law [is] considered to
be a deductible temporary difference in applying [ASC 740].” Accordingly, entities recognize DTAs and
related tax benefits on the basis of cumulative compensation cost recorded for awards that ordinarily
would result in future tax deductions. This guidance applies irrespective of whether an award is
classified as equity or a liability. If the cost of an award that will ordinarily result in a deduction for tax
purposes is capitalized (e.g., as part of inventory or a fixed asset), the capitalized cost also becomes part
of the tax basis of the asset.
For awards that would not ordinarily result in future tax deductions, the cumulative amount of
compensation cost recognized in the financial statements would be treated as a permanent difference
and would be an item (or part of an item) that reconciles the entity’s statutory tax rate to its effective tax
rate. For public entities, disclosure of this reconciliation is required by ASC 740-10-50-12. Any capitalized
cost of an award that would not ordinarily result in a future deduction would not be treated as part of
the tax basis of the asset.
The DTA associated with share-based payment awards (gross of any valuation allowance) is computed
on the basis of the gross temporary difference (i.e., the cumulative amount of compensation cost
recognized in the financial statements) and, for equity-classified awards, is not subsequently affected
by changes in the entity’s stock price. An entity should not remeasure or write off the gross DTA as
a result of a change in its stock price. For example, even if an entity’s stock price has declined so
significantly that a stock option award’s exercise is unlikely to occur or that the intrinsic value on the
exercise date will most likely be less than the cumulative compensation cost recognized in the financial
statements, the gross DTA is not adjusted. However, for share-based payment awards classified as
liabilities, the measurement of the gross DTA does implicitly take into account the entity’s current stock
price since liability awards are remeasured at the end of each reporting period. The DTA resulting from
compensation cost on liability awards would change as the fair-value-based measure of the awards
changes.
The cumulative amount of compensation cost recognized in the financial statements may be greater or
less than the amount of actual tax deductions for share-based payment awards (e.g., the tax deduction
determined when a restricted stock award vests or when a stock option award is exercised). Differences
in such amounts are referred to as excess tax benefits (when the amount of the deduction exceeds the
compensation cost recognized in the financial statements) and tax deficiencies (when the amount of
the deduction is less than the compensation cost recognized in the financial statements). In accordance
with ASC 718-740-35-2, the excess tax benefits and tax deficiencies are recognized as decreases or
increases to current tax expense or benefit in the period the excess tax benefit or tax deficiency arises
(i.e., the period in which the tax deduction arises or the period in which an option’s expiration occurs).
This results in a permanent difference between the amount of cumulative compensation for financial
reporting purposes and the deduction taken for income tax purposes and has an impact on an entity’s
effective tax rate in the period in which the excess or deficiency arises.
431
All income tax effects of share-based payment awards are recognized in the income statement.
This includes any income tax benefits associated with compensation cost recognized in the financial
statements and, in accordance with ASC 718-740-35-2, any excess tax benefits or tax deficiencies that
arise when the actual tax deductions are determined.
For additional information about the accounting for income taxes associated with share-based payment
awards, see Chapter 10 of Deloitte’s Roadmap Income Taxes.
432
Chapter 12 — Presentation
This chapter discusses presentation matters related to the statement of financial position, statement of
operations, statement of cash flows, and EPS.
12.1 Statement of Financial Position

12.1.1 Receivables
ASC 505-10
Receivables for Issuance of Equity

45-2 An entity may receive a note, rather than cash, as a contribution to its equity. The transaction may be
a sale of capital stock or a contribution to paid-in capital. Reporting the note as an asset is generally not
appropriate, except in very limited circumstances in which there is substantial evidence of ability and intent
to pay within a reasonably short period of time, for example, as discussed for public entities in paragraph
210-10-S99-1 (paragraphs 27 through 29), which requires a deduction of the receivable from equity. However,
such notes may be recorded as an asset if collected in cash before the financial statements are issued or are
available to be issued (as discussed in Section 855-10-25).
SAB Topic 4.E, Receivables From Sale of Stock [Reproduced in ASC 310-10-S99-2]
Facts: Capital stock is sometimes issued to officers or other employees before the cash payment is received.
Question: How should the receivables from the officers or other employees be presented in the balance
sheet?
Interpretive Response: The amount recorded as a receivable should be presented in the balance sheet as
a deduction from stockholders’ equity. This is generally consistent with Rule 5-02.30 of Regulation S-X which
states that accounts or notes receivable arising from transactions involving the registrant’s capital stock should
be presented as deductions from stockholders’ equity and not as assets.
It should be noted generally that all amounts receivable from officers and directors resulting from sales of stock
or from other transactions (other than expense advances or sales on normal trade terms) should be separately
stated in the balance sheet irrespective of whether such amounts may be shown as assets or are required to
be reported as deductions from stockholders’ equity.
The staff will not suggest that a receivable from an officer or director be deducted from stockholders’ equity
if the receivable was paid in cash prior to the publication of the financial statements and the payment date is
stated in a note to the financial statements. However, the staff would consider the subsequent return of such
cash payment to the officer or director to be part of a scheme or plan to evade the registration or reporting
requirements of the securities laws.
433
Generally, receivables that result from the issuance of shares classified as permanent or mezzanine
equity should be presented as a reduction of each respective class of stock (i.e., contra-equity). That
is, receivables that result from the issuance of shares classified as permanent equity generally should
be presented as a reduction of permanent equity in accordance with ASC 505-10-45-2. Similarly,
receivables that result from the issuance of shares classified as mezzanine equity should be presented
as a reduction of mezzanine equity.
SAB Topic 4.E (reproduced in ASC 310-10-S99-2) generally requires entities to classify any outstanding
receivables from officers or other employees related to the issuance of stock to officers or other
employees as a deduction from stockholders’ equity rather than as an asset.
Asset classification of such receivables may be appropriate only when the receivable is fully repaid in
cash before the financial statements are issued. The date of payment must be disclosed in the notes
to the financial statements. SAB Topic 4.E cautions, however, that the SEC staff would consider any
subsequent return of cash to the officer or employee as potentially representing an effort “to evade the
registration or reporting requirements of the securities laws.” Further, receivables of this nature must
be disclosed separately regardless of whether they are classified as an asset or as a deduction from
equity. Entities preparing to file a registration statement with the SEC should be particularly cognizant of
the potential legal ramifications associated with loans to employees and should consult with their legal
counsel to address any issues well before their public offering.
In addition, an entity that allows an employee to finance the purchase of shares should consider
whether recourse or nonrecourse notes have been tendered. Nonrecourse notes are not recognized
because such a financing is accounted for, in substance, as stock options. See Section 3.11.
12.1.2 Deferred Tax Assets

As discussed in Section 4.12.2, NQSOs are options that do not qualify for treatment as ISOs or ESPPs
under the provisions of IRC Sections 421 through 424. NQSOs give employers more flexibility than ISOs.
In accordance with ASC 740-10-45-4, an entity must classify the DTA as noncurrent on the balance
sheet.
See Chapter 10 of Deloitte’s Roadmap Income Taxes for a discussion of the income tax effects of share-
based payments.
434
12.1.3 Capitalization of Inventory
SAB Topic 14.I, Capitalization of Compensation Cost Associated With Share-Based Arrangements
[Reproduced in ASC 718-10-S99-1]
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.94
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 managements 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
2002,95 is effective.

94
Release No. 34-47986, June 5, 2003, Managements Report on Internal Control Over Financial Reporting and Certification
95
of Disclosure in Exchange Act Period Reports.
If compensation cost associated with share-based payment awards is part of the cost of inventory,
an entity should initially capitalize it as inventory and later recognize it in the income statement when
the inventory is consumed. However, the SEC staff has indicated that it may be reasonable for an
entity instead to adjust the period-end inventory balance for compensation cost through a period-end
adjustment and not incorporate the cost in its inventory costing system.
12.1.4 Fully Vested Nonemployee Awards

ASC 718-10
Classification of Assets Other Than a Note or a Receivable for Nonemployee Awards

45-3 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.
For additional information about the classification of assets, other than a note or a receivable, that are
received in exchange for fully vested nonforfeitable equity instruments, see Section 9.7.
12.1.5 Presentation of Awards With Repurchase Features That Function as

Vesting Conditions
As discussed in Section 3.4.3, repurchase features included in a share-based payment award may at
times function in substance as vesting conditions. For example, a stock option or similar instrument may
435
be “early exercised” and include such repurchase features. An early exercise of a stock option or similar
instrument refers to a grantee’s ability to change his or her tax position by exercising an option or similar
instrument and receiving shares before the award is vested. The early exercise of the stock option is
generally not considered substantive for accounting purposes given the repurchase features included
in such awards. However, the shares issued to a grantee upon an early exercise of a stock option or
similar instrument may be considered legally outstanding common stock. In accordance with SEC
Regulation S-X, Rule 5-02(29), SEC registrants are required to disclose the number of common shares
outstanding on the balance sheet. If the shares are deemed to be legally outstanding, the number of
shares disclosed as outstanding on the balance sheet may differ from the number of shares outstanding
for accounting purposes. Entities should consider whether disclosing this difference is necessary on
the basis of their facts and circumstances. These considerations also apply to restricted stock with
repurchase features that function as vesting conditions.
12.2 Statement of Operations
ASC 718 requires compensation cost from share-based payment awards to be (1) recorded in
net income, (2) either expensed or capitalized (and subsequently expensed) in an entity’s financial
statements, and (3) classified appropriately as either equity or a liability in accordance with the
classification criteria in ASC 718 (see Chapter 5). However, ASC 718 provides little guidance on how
compensation cost associated with share-based payment awards should be presented in the statement
of operations.
12.2.1 Classification of Compensation Expense

SAB Topic 14.F, Classification of Compensation Expense Associated With Share-Based Payment
Arrangements [Reproduced in ASC 718-10-S99-1]
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.87 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.
87
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.
The SEC staff believes that compensation expense related to share-based payment arrangements (e.g.,
cost of sales, R&D, selling and administrative expenses) should be presented within the appropriate
line items on the face of the statement of operations and not separately within a single share-based
compensation line item. That is, presentation in the statement of operations should not be governed by
the form of consideration paid (e.g., cash or share-based payment). The staff believes that instead, an
entity could consider disclosing the amount of expense related to share-based payment arrangements
presented within 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, in the cash flow
statement, in the footnotes to the financial statements, or in MD&A.
436
The following is an example of an acceptable disclosure of share-based compensation expense

presented within specific line items:
Revenue $ 100
Cost of sales (including noncash compensation expense of $10) 40
Gross profit 60
Selling expense (including noncash compensation expense of $5) 20
General and administrative expense (including noncash compensation expense of $5) 25
Total operating expenses 45
Income from operations $ 15
12.2.2 Share-Based Payment Awards Granted to Employees and

Nonemployees of an Equity Method Investee
ASC 323-10

25-5 In the circumstances described in paragraph 323-10-25-3, other equity method investors in an investee
(that is, noncontributing investors) shall recognize income equal to the amount that their interest in the
investee’s net book value has increased (that is, their percentage share of the contributed capital recognized by
the investee) as a result of the disproportionate funding of the compensation costs. Further, those other equity
method investors shall recognize their percentage share of earnings or losses in the investee (inclusive of any
expense recognized by the investee for the share-based compensation funded on its behalf).
SEC Observer Comment: Accounting by an Investor for Stock-Based Compensation Granted to Employees
of an Equity Method Investee
S99-4 The following is the text of SEC Observer Comment: Accounting by an Investor for Stock-Based
Compensation Granted to Employees of an Equity Method Investee.
Paragraph 323-10-25-3 provides guidance on the accounting by an investor for stock-based
compensation based on the investor’s stock granted to employees of an equity method investee.
Investors that are SEC registrants should classify any income or expense resulting from application of
this guidance in the same income statement caption as the equity in earnings (or losses) of the investee.
437
ASC 323 provides guidance on share-based payment awards granted by an investor to employees and
nonemployees of an equity method investee. Generally, investors of the equity method investee (both
the contributing investor and noncontributing investors) classify any income or expense associated with
the awards in the same caption as the equity in earnings of the investee.
12.2.3 Nonemployee Awards Issued in Exchange for Goods or Services

The SEC staff has reviewed a number of cases in which entities have issued share-based payment
awards (e.g., warrants, shares, or convertible instruments) to suppliers, service providers, customers, or
partners. The staff has generally held as follows:
• When share-based payment awards are issued to customers or potential customers in

arrangements in which the awards will not vest or become exercisable without purchases by the
recipient, the related cost must be reported as a sales discount — in other words, as a reduction
of revenue.
• When awards are issued to suppliers or potential suppliers and they will not vest or become
exercisable unless the recipient provides goods or services to the issuer, the cost of the award
should be reported as a cost of the related goods or services.
• Separate line items in the statement of operations should not be presented for the apparent
purpose of emphasizing that a portion of the sales discounts or expenses did not involve a cash
outlay. This requirement is consistent with the guidance in SAB Topic 14.F (see Section 12.2.1).
• Awards that do not require any performance from the counterparty are related to past
transactions and should therefore be classified appropriately (e.g., as cost of sales or reduction
of revenue and not as marketing or nonoperating expenses).
12.2.4 Payroll Taxes
ASC 718-10
25-23 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.
Payroll taxes incurred as a result of share-based payment transactions should be reflected as operating
expenses.
12.3 Statement of Cash Flows

Because the receipt of goods or services in exchange for a share-based payment award is a noncash
item, the award is not presented as a direct cash outflow in the statement of cash flows. However, under
the indirect method, an entity would present the compensation cost recognized in net income as a
reconciling item in arriving at cash flows from operations.
In addition, an entity presents other effects of share-based payment awards as follows:
• Any cash paid by a grantee (e.g., the exercise price of a stock option) to the entity for an award is
classified as a cash inflow from financing activities.
• Any cash paid to settle an equity-classified award is classified as a cash outflow for financing
activities. However, if the amount paid exceeds the fair-value-based measure of the award, the
excess is compensation cost and classified as a cash outflow for operating activities.
438
• Any cash paid to settle a liability-classified award represents compensation and is classified as a
cash outflow for operating activities.
• Regardless of whether an entity meets an employee’s statutory tax withholding requirement

through either a net settlement feature or a repurchase of shares, the entity must account
for the withholding as, in substance, two transactions in the statement of cash flows. First,
the gross issuance of shares is presented as a financing activity (any cash received from the
employee is classified as a cash inflow from financing activities, and if no cash is received, the
gross issuance of shares is presented as a noncash financing activity). Second, the entity is
deemed to have repurchased a portion of the shares. While the employee does not receive cash
directly, the entity has, in substance, repurchased shares from the employee and remitted the
cash consideration to the tax authority on the employee’s behalf. Because the cash payment is
related to a repurchase of stock, it is classified as a cash outflow for financing activities.
• Any income tax benefit received for an award is classified as operating activities in the same
manner as other cash flows related to income taxes.
For additional information about classifying the effects of share-based payment awards in the statement
of cash flows, see Section 7.3 of Deloitte’s Roadmap Statement of Cash Flows.
12.4 Earnings per Share

ASC 718-10
Earnings per Share

45-1 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
260-10-45-48 through 45-57. 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.
45-2 Paragraphs 260-10-45-29 through 45-34 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.
In computing EPS, an entity should consider how a share-based payment award may affect (1) income
available to common shareholders (i.e., the numerator in the EPS calculation) and (2) the weighted-
average number of common shares or dilutive potential common shares (i.e., the denominator in
the EPS calculation). Because an entity recognizes the fair-value-based measure of an award as
compensation cost (or as a reduction of revenue) in arriving at the entity’s income available to common
shareholders, awards granted in return for goods or services or as a sales incentive to a customer will
typically affect the EPS numerator. That is, the compensation cost that is expensed will reduce income
available to common shareholders.
439
12.4.1 Basic EPS
ASC 260-10
Computation of Basic EPS

45-10 Basic EPS shall be computed by dividing income available to common stockholders (the numerator) by
the weighted-average number of common shares outstanding (the denominator) during the period. Shares
issued during the period and shares reacquired during the period shall be weighted for the portion of the
period that they were outstanding. See Example 1 (paragraph 260-10-55-38) for an illustration of this guidance.
During the requisite service period or nonemployee’s vesting period, share-based payment awards do
not affect the computation of basic EPS (other than the effect of compensation cost as a reduction of
income available to common shareholders) unless such awards are considered participating securities
(i.e., the awards participate in current-period earnings on a nonforfeitable basis, usually in the form of
dividend distributions, with common shareholders). An entity must apply the two-class method when
computing basic and diluted EPS for such awards (see Section 12.4.3).
Once the good has been delivered, the service has been rendered, or the revenue related to the
sales incentive has been recognized, vested awards that are considered outstanding common shares
affect the denominator in the calculation of basic EPS. That is, such awards will be included in the
weighted-average number of common shares from the date on which they become vested outstanding
common shares. If the awards do not become outstanding common shares during the period and are
not considered participating securities, they generally are not included in the calculation of basic EPS.
However, contingently issuable shares should be included in the denominator of basic EPS when there
are no circumstances in which those shares would not be issued.
Share-based payment awards often contain clawback features. See Section 3.9 for a discussion of such
features. Because clawback features are protective provisions, ASC 718 requires that the effect of a
clawback feature be accounted for only when the contingent event that triggers the clawback occurs.
In a manner consistent with this guidance, vested common shares issued in a share-based payment
transaction should be considered outstanding shares in the calculation of basic EPS from the date
vesting is complete. It would not be appropriate to exclude such common shares from the denominator
of the calculation of basic EPS on the basis of the guidance in ASC 260 on contingently issuable
(returnable) shares. This conclusion is consistent with paragraph 92 of the Background Information
and Basis for Conclusions of FASB Statement 128, which indicates that vested shares for which the
consideration has been received should be included in the calculation of basic EPS. It is also consistent
with informal discussions with the FASB staff.
12.4.2 Diluted EPS
ASC 260-10
Computation of Diluted EPS

45-16 The computation of diluted EPS is similar to the computation of basic EPS except that the denominator is
increased to include the number of additional common shares that would have been outstanding if the dilutive
potential common shares had been issued. In addition, in computing the dilutive effect of convertible securities,
the numerator is adjusted to add back any convertible preferred dividends and the after-tax amount of interest
recognized in the period associated with any convertible debt. The numerator also is adjusted for any other
changes in income or loss that would result from the assumed conversion of those potential common shares,
such as profit-sharing expenses. Similar adjustments also may be necessary for certain contracts that provide
the issuer or holder with a choice between settlement methods. See Example 1 (paragraph 260-10-55-38) for
an illustration of this guidance.
440
45-16 The computation of diluted EPS is similar to the computation of basic EPS except that the denominator
is increased to include the number of additional common shares that would have been outstanding if the
dilutive potential common shares had been issued. In computing the dilutive effect of convertible securities,
the numerator is adjusted in accordance with the guidance in paragraph 260-10-45-40. Adjustments also
may be necessary for certain contracts that provide the issuer or holder with a choice between settlement
methods. See Example 1 (paragraph 260-10-55-38) for an illustration of this guidance.
No Antidilution
45-17 The computation of diluted EPS shall not assume conversion, exercise, or contingent issuance of securities
that would have an antidilutive effect on EPS. Shares issued on actual conversion, exercise, or satisfaction of
certain conditions for which the underlying potential common shares were antidilutive shall be included in the
computation as outstanding common shares from the date of conversion, exercise, or satisfaction of those
conditions, respectively. In determining whether potential common shares are dilutive or antidilutive, each issue
or series of issues of potential common shares shall be considered separately rather than in the aggregate.
45-18 Convertible securities may be dilutive on their own but antidilutive when included with other potential
common shares in computing diluted EPS. To reflect maximum potential dilution, each issue or series of issues
of potential common shares shall be considered in sequence from the most dilutive to the least dilutive. That
is, dilutive potential common shares with the lowest earnings per incremental share shall be included in diluted
EPS before those with a higher earnings per incremental share. Example 4 (see paragraph 260-10-55-57)
illustrates that provision. Options and warrants generally will be included first because use of the treasury stock
method does not affect the numerator of the computation. An entity that reports a discontinued operation
in a period shall use income from continuing operations (adjusted for preferred dividends as described in
paragraph 260-10-45-11) as the control number in determining whether those potential common shares are
dilutive or antidilutive. That is, the same number of potential common shares used in computing the diluted
per-share amount for income from continuing operations shall be used in computing all other reported diluted
per-share amounts even if those amounts will be antidilutive to their respective basic per-share amounts.
(See paragraph 260-10-45-3.) The control number excludes income from continuing operations attributable
to the noncontrolling interest in a subsidiary in accordance with paragraph 260-10-45-11A. Example 14 (see
paragraph 260-10-55-90) provides an illustration of this guidance.
45-19 Including potential common shares in the denominator of a diluted per-share computation for
continuing operations always will result in an antidilutive per-share amount when an entity has a loss from
continuing operations or a loss from continuing operations available to common stockholders (that is, after
any preferred dividend deductions). Although including those potential common shares in the other diluted
per-share computations may be dilutive to their comparable basic per-share amounts, no potential common
shares shall be included in the computation of any diluted per-share amount when a loss from continuing
operations exists, even if the entity reports net income.
45-20 The control number for determining whether including potential common shares in the diluted EPS
computation would be antidilutive should be income from continuing operations (or a similar line item above
net income if it appears on the income statement). As a result, if there is a loss from continuing operations,
diluted EPS would be computed in the same manner as basic EPS is computed, even if an entity has net income
after adjusting for a discontinued operation. Similarly, if an entity has income from continuing operations but
its preferred dividend adjustment made in computing income available to common stockholders in accordance
with paragraph 260-10-45-11 results in a loss from continuing operations available to common stockholders,
diluted EPS would be computed in the same manner as basic EPS.
Conversion Rate or Exercise Price

45-21 Diluted EPS shall be based on the most advantageous conversion rate or exercise price from the
standpoint of the security holder. Previously reported diluted EPS data shall not be retroactively adjusted for
subsequent conversions or subsequent changes in the market price of the common stock.
441
45-21A Changes in an entity’s share price may affect the exercise price of a financial instrument or the
number of shares that would be used to settle the financial instrument. For example, when the principal of a
convertible debt instrument is required to be settled in cash but the conversion premium is required to (or
may) be settled in shares, the number of shares to be included in the diluted EPS denominator is affected
by the entity’s share price. In applying both the treasury stock method and the if-converted method of
calculating diluted EPS, the average market price shall be used for purposes of calculating the denominator
for diluted EPS when the number of shares that may be issued is variable, except for contingently issuable
shares within the scope of the guidance in paragraphs 260-10-45-48 through 45-57. See paragraphs 260-10-
55-4 through 55-5 for implementation guidance on determining an average market price.
While share-based payment awards do not affect the calculation of basic EPS (other than the effect of
compensation cost as a reduction of income available to common shareholders) during the requisite
service period or nonemployee’s vesting period (unless the award is a participating security), an entity
generally includes them in the denominator when calculating diluted EPS if the effect is dilutive on the
basis of the antidilution sequencing requirements of ASC 260. Further, awards (e.g., stock options or
warrants) that do not become outstanding common shares when the good is delivered or the service is
rendered, and that are not considered participating securities, are not included in the calculation of basic
EPS but may be included in the denominator of diluted EPS before they are settled (e.g., are exercised,
are canceled, or expire).
An entity may change the terms or conditions of a share-based payment award. Any such change is
considered a modification under ASC 718. ASC 718-20-35-3 states, in part, that “[e]xcept as described in
paragraph 718-20-35-2A, a modification of the terms or conditions of an equity award shall be treated
as an exchange of the original award for a new award.” ASC 718-30-35-5 contains similar guidance for
liability-classified awards and states, in part, that “[a] modification of a liability award is accounted for as
the exchange of the original award for a new award.” In accordance with this guidance, a modification
of a share-based payment award that is not subject to the exception in ASC 718-20-35-2A is treated as
a cancellation of the existing award and the issuance of a new award. In a manner consistent with the
guidance in ASC 718, an entity should treat the original and modified awards as two separate awards
in calculating diluted EPS. Thus, when the treasury stock method applies to a modified share-based
payment award, an entity would perform the following two treasury stock method calculations:
• Calculations based on the terms of the award and the average market price of the entity’s
common stock for the period during the financial reporting period before the modification
(weighted, as appropriate, for the period).
• Calculations based on the terms of the award and the average market price of the entity’s
common stock for the period during the financial reporting period after the modification
(weighted, as appropriate, for the period).
The sum of these two calculations will equal the incremental common shares that are included in the
calculation of diluted EPS for the period.
ASC 718-20-35-2A addresses situations in which an entity modifies a share-based payment award but
is not required to apply modification accounting. Entities will need to consider the specific facts and
circumstances associated with such types of modifications to determine whether they should be treated
as a single award or two separate awards in the calculation of diluted EPS in the period that includes the
change to the terms or conditions of the award.
442
Changing Lanes
In August 2020, the FASB issued ASU 2020-06, which simplifies the accounting for certain
financial instruments with characteristics of liabilities and equity, including convertible
instruments and contracts on an entity’s own equity. Most of the ASU’s guidance does not affect
this Roadmap. However, the ASU clarifies that the “average market price should be used to
calculate the diluted EPS denominator” when the exercise price or the number of shares that
may be issued is variable, except for certain contingently issuable shares.
See Deloitte’s August 5, 2020, Heads Up for additional information about ASU 2020-06, including
its effective dates.
12.4.2.1 Treasury Stock Method

ASC 260-10
Options, Warrants, and Their Equivalents and the Treasury Stock Method
45-22 The dilutive effect of outstanding call options and warrants (and their equivalents) issued by the
reporting entity shall be reflected in diluted EPS by application of the treasury stock method unless the
provisions of paragraphs 260-10-45-35 through 45-36 and 260-10-55-8 through 55-11 require that another
method be applied. Equivalents of options and warrants include nonvested stock granted under a share-based
payment arrangement, stock purchase contracts, and partially paid stock subscriptions (see paragraph 260-10-
55-23). Antidilutive contracts, such as purchased put options and purchased call options, shall be excluded
from diluted EPS.
45-23 Under the treasury stock method:

a. Exercise of options and warrants shall be assumed at the beginning of the period (or at time of issuance,
if later) and common shares shall be assumed to be issued.
b. The proceeds from exercise shall be assumed to be used to purchase common stock at the average
market price during the period. (See paragraphs 260-10-45-29 and 260-10-55-4 through 55-5.)
c. The incremental shares (the difference between the number of shares assumed issued and the number
of shares assumed purchased) shall be included in the denominator of the diluted EPS computation.
Example 15 (see paragraph 260-10-55-92) provides an illustration of this guidance.
45-23 Under the treasury stock method:

a. Exercise of options and warrants shall be assumed at the beginning of the period (or at time of
issuance, if later) and common shares shall be assumed to be issued.
b. The proceeds from exercise shall be assumed to be used to purchase common stock at the average
market price during the period. (See paragraphs 260-10-45-29 and 260-10-55-4 through 55-5.)
c. The incremental shares (the difference between the number of shares assumed issued and the
number of shares assumed purchased) shall be included in the denominator of the diluted EPS
computation.
Example 15 (see paragraph 260-10-55-92) provides an illustration of this guidance. See paragraph 260-10-
45-21A if the exercise price of a financial instrument or the number of shares that would be used to settle
the financial instrument is variable.
45-24 Paragraph not used.
443
45-25 Options and warrants will have a dilutive effect under the treasury stock method only when the average
market price of the common stock during the period exceeds the exercise price of the options or warrants
(they are in the money). Previously reported EPS data shall not be retroactively adjusted as a result of changes
in market prices of common stock.
45-26 Dilutive options or warrants that are issued during a period or that expire or are cancelled during a
period shall be included in the denominator of diluted EPS for the period that they were outstanding. Likewise,
dilutive options or warrants exercised during the period shall be included in the denominator for the period
prior to actual exercise. The common shares issued upon exercise of options or warrants shall be included in
the denominator for the period after the exercise date. Consequently, incremental shares assumed issued shall
be weighted for the period the options or warrants were outstanding, and common shares actually issued shall
be weighted for the period the shares were outstanding.
45-27 Paragraphs 260-10-55-3 through 55-11 provide additional guidance on the application of the treasury
stock method.
Share-Based Payment Arrangements

45-28 The provisions in paragraphs 260-10-45-28A through 45-31 apply to share-based awards issued to
grantees under a share-based payment arrangement in exchange for goods and services or as consideration
payable to a customer.
45-28A Awards of share options and nonvested shares (as defined in Topic 718) to be issued to a grantee
under a share-based payment arrangement are considered options for purposes of computing diluted
EPS. Such share-based awards shall be considered to be outstanding as of the grant date for purposes of
computing diluted EPS even though their exercise may be contingent upon vesting. Those share-based
awards are included in the diluted EPS computation even if the grantee may not receive (or be able to sell) the
stock until some future date. Accordingly, all shares to be issued shall be included in computing diluted EPS
if the effect is dilutive. The dilutive effect of share-based payment arrangements shall be computed using the
treasury stock method. If the 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 were outstanding. See Example 8 (paragraph 260-10-55-68).
45-28B In applying the treasury stock method, all dilutive potential common shares, regardless of whether
they are exercisable, are treated as if they had been exercised. The treasury stock method assumes that the
proceeds upon exercise are used to repurchase the entity’s stock, reducing the number of shares to be added
to outstanding common stock in computing EPS.
An entity generally includes the dilutive effect of share-based payment awards (e.g., restricted
stock, stock options) in the denominator of the calculation of diluted EPS by applying the treasury
stock method, under which it is assumed that any service condition will be met. When applying the
treasury stock method to a stock option, the entity also assumes that two hypothetical transactions
have occurred. The first is the hypothetical exercise of the award (or, for a restricted stock award,
the hypothetical vesting of the award); the second is the hypothetical repurchase of shares at the
average market price during the period by using the assumed proceeds that will be generated from
the hypothetical exercise of the award (or, for a restricted stock award, the hypothetical vesting for the
award). The incremental shares that would be hypothetically issued are the number of shares assumed
to be issued upon hypothetical exercise of the award in excess of the number of shares assumed to
be hypothetically repurchased with the assumed proceeds. The incremental shares are included in the
number of diluted potential common shares as a component of the denominator in the calculation of
diluted EPS.
444
While the treasury stock method applies to both vested and unvested stock options, it is used for such
awards only when the average market price of the entity’s common stock during the period exceeds
the exercise price of the awards (i.e., the award is in the money) on an award-by-award basis. Thus,
an entity needs to perform a separate treasury stock method computation for each individual in-the-
money award. An entity would perform the same computation for awards that are granted on the same
day with the same terms and conditions (the awards would presumably have the same grant-date fair-
value-based measure). Out-of-the-money awards are considered antidilutive and excluded from the
denominator in the calculation of diluted EPS. The determination of whether an award is in-the-money
or out-of-the-money is made on an individual-award basis.
12.4.2.1.1 Assumed Proceeds
ASC 260-10
45-29 In applying the treasury stock method described in paragraph 260-10-45-23, the assumed proceeds
shall be the sum of both of the following:
a. The amount, if any, the grantee must pay upon exercise.
b. The amount of cost attributed to share-based payment awards (within the scope of Topic 718 on stock
compensation) not yet recognized. This amount includes share-based payment awards that are not
contingent upon satisfying certain conditions as described in paragraph 260-10-45-32 and contingently
issuable shares that have been determined to be included in the computation of diluted EPS as
45-29A Under paragraphs 718-10-35-1D and 718-10-35-3, the effect of forfeitures is taken into account
by recognizing compensation cost for those instruments for which the employee’s requisite service has
been rendered or the nonemployee’s vesting conditions have been met and no compensation cost shall be
recognized for instruments that grantees forfeit because a service or performance condition is not satisfied.
See Example 8 (paragraph 260-10-55-68) for an illustration of this guidance.
When determining the amount of assumed proceeds that a share-based payment award will generate,
an entity aggregates (1) the exercise price of the award, if any, and (2) the average amount of
compensation cost attributed to share-based payment awards not yet recognized.1 Because there is no
exercise price for restricted stock awards, the entity includes in the assumed proceeds only the average
amount of unrecognized compensation cost attributed to future goods or services not yet recognized.
12.4.2.1.2 Period Outstanding
An entity must take into account the amount of time a share-based payment award was outstanding
during the reporting period. If an award was outstanding for the entire reporting period, the incremental
shares determined under the treasury stock method are included in the computation of diluted EPS
for the entire reporting period. By contrast, if an award was exercised (or, for a restricted stock award,
becomes vested) or forfeited during the reporting period, the incremental shares are included only for
the period in which the award was outstanding when the treasury stock method is applied. Once the
award is exercised (or, for a restricted stock award, becomes vested), the shares issued are considered
outstanding common shares and are included in the weighted-average number of common shares
outstanding (i.e., the denominator in the calculation of basic and diluted EPS).
1
The inclusion of the average amount of unrecognized compensation cost attributed to future goods or services not yet recognized is unique to
share-based payment awards. That is, this component is only included in the assumed proceeds for share-based payment awards.
445
12.4.2.1.3 Quarter-to-Date Versus Year-to-Date Computations

ASC 260-10
Applying the Treasury Stock Method

Year-to-Date Computations
55-3 The number of incremental shares included in quarterly diluted EPS shall be computed using the
average market prices during the three months included in the reporting period. For year-to-date diluted EPS,
the number of incremental shares to be included in the denominator shall be determined by computing a
year-to-date weighted average of the number of incremental shares included in each quarterly diluted EPS
computation. Example 1 (see paragraph 260-10-55-38) provides an illustration of that provision.
Editor’s Note: The level 2 heading that precedes paragraph 260-10-55-3 will be amended upon transition as
shown below. Simultaneously, the level 3 heading will be deleted. The content of the paragraph will not change.
Applying the Treasury Stock Method: Year-to-Date Computations

55-3 The number of incremental shares included in quarterly diluted EPS shall be computed using
the average market prices during the three months included in the reporting period. For year-to-date
diluted EPS, the number of incremental shares to be included in the denominator shall be determined
by computing a year-to-date weighted average of the number of incremental shares included in each
quarterly diluted EPS computation. Example 1 (see paragraph 260-10-55-38) provides an illustration of
that provision.
55-3A Computation of year-to-date diluted EPS when an entity has a year-to-date loss from continuing
operations including one or more quarters with income from continuing operations and when in-the-money
options or warrants were not included in one or more quarterly diluted EPS computations because there was
a loss from continuing operations in those quarters is as follows. In computing year-to-date diluted EPS, year-
to-date income (or loss) from continuing operations shall be the basis for determining whether or not dilutive
potential common shares not included in one or more quarterly computations of diluted EPS shall be included
in the year-to-date computation.
55-3B Therefore:
a. When there is a year-to-date loss, potential common shares should never be included in the
computation of diluted EPS, because to do so would be antidilutive.
b. When there is year-to-date income, if in-the-money options or warrants were excluded from one or
more quarterly diluted EPS computations because the effect was antidilutive (there was a loss from
continuing operations in those periods), then those options or warrants should be included in the
diluted EPS denominator (on a weighted-average basis) in the year-to-date computation as long as the
effect is not antidilutive. Similarly, contingent shares that were excluded from a quarterly computation
solely because there was a loss from continuing operations should be included in the year-to-date
computation unless the effect is antidilutive.
Example 12 (see paragraph 260-10-55-85) illustrates this guidance.
446
When applying the treasury stock method to a quarterly period, an entity should use the average market
price for the period to determine the number of incremental shares to include in the denominator
of the calculation of diluted EPS. That is, the entity computes the number of incremental shares for
the quarterly period as though that period is a discrete period. By contrast, in the denominator of the
calculation of diluted EPS for the year-to-date period, an entity includes a weighted-average number
of incremental shares for each of the quarterly periods. The average market price for the year-to-date
period is not used as though the year-to-date period was a separate discrete period. Example 1 in ASC
260-10-55-38 through 55-50 and Example 12 in ASC 260-10-55-85 through 55-87 illustrate quarter-to-
date and year-to-date EPS computations.
12.4.2.1.4 Forfeitures
the number of awards that are expected to vest or (2) account for forfeitures when they occur. The
entity’s election will affect the amount of compensation cost included in income available to common
shareholders (the numerator in the calculation of diluted EPS). However, regardless of the entity’s policy
election, the denominator in the calculation of diluted EPS is based on the actual number of awards
outstanding (i.e., the number of awards is reduced only for actual forfeitures) in a given reporting period
provided that the effect is dilutive. Once an entity has determined the number of outstanding awards
that will have a dilutive effect on the computation of diluted EPS, the entity then uses the treasury stock
method to determine the number of incremental shares to include in the denominator of the calculation
of diluted EPS.
For example, an entity that elects to estimate forfeitures may determine that only 90 percent of the
share-based payment awards issued to grantees are expected to eventually vest even though none
have actually been forfeited yet. Accordingly, only 90 percent of the awards’ fair-value-based measure
is recognized as compensation cost over the requisite service period or nonemployee’s vesting period.
However, when determining the number of incremental shares to include in the denominator of the
calculation of diluted EPS, an entity must assume that all outstanding dilutive awards that contain only
a service condition will vest or become exercisable. Therefore, when computing diluted EPS, the entity
must (1) determine the number of all outstanding awards that are dilutive and (2) apply the treasury
stock method.
When the treasury stock method is applied, the assumed proceeds are also calculated on the basis
of the actual number of all outstanding dilutive awards regardless of the entity’s forfeiture policy
election or whether certain of those awards are not expected to eventually vest. The amount of average
unrecognized cost is therefore based on the total number of outstanding dilutive awards at the
beginning of the period and at the end of the period.
447
12.4.2.1.5 Treasury Stock Method Examples

The examples below illustrate the application of the treasury stock method to share-based payment
awards in the computation of diluted EPS.
ASC 260-10
Example 8: Application of the Treasury Stock Method to a Share-Based Payment Arrangement

55-68 This Example illustrates the guidance in paragraph 260-10-45-28A for the application of the treasury
stock method when share options are forfeited.
55-69 Entity A adopted a share option plan on January 1, 20X7, and granted 900,000 at-the-money share
options with an exercise price of $30. All share options vest at the end of three years (cliff vesting). Entity A’s
accounting policy is to estimate the number of forfeitures expected to occur in accordance with paragraph
718-10-35-1D or 718-10-35-3. At the grant date, Entity A assumes an annual forfeiture rate of 3 percent and
therefore expects to receive the service for 821,406 [900,000 × (.97 to the third power)] share options. On
January 1, 20X7, the fair value of each share option granted is $14.69. Grantees forfeited 15,000 stock options
ratably during 20X7.
55-69A The average stock price during 20X7 is $44. Net income for the period is $97,385,602. For the year
ended December 31, 20X7, there are 25,000,000 weighted-average common shares outstanding. This guidance
also applies if the service inception date precedes the grant date.
448
55-70 The following table illustrates computation of basic and diluted EPS for the year ended December 31,
20X7.
Computation of Basic EPS for the Year Ended December 31, 20X7:
Net income $ 97,385,602
Weighted-average common shares outstanding 25,000,000
Basic earnings per share $ 3.90
Computation of assumed proceeds for diluted earnings per share:
Amount employees would pay if the weighted-average number of
options outstanding were exercised using the average exercise price
(892,500(b) × $30) $ 26,775,000
Average unrecognized compensation cost in 20X7 (see computation) 10,944,050
Assumed proceeds $ 37,719,050
Computation of average unrecognized compensation cost in 20X7:
Beginning of period
Unrecognized compensation cost (900,000 × $14.69) $ 13,221,000
End of the period
Beginning of period $ 13,221,000
Annual compensation cost recognized during 20X7,
based on estimated forfeitures (4,022,151)(a)
Annual compensation cost not recognized during the period related to
outstanding options at December 31, 20X7, for which the requisite
service is not expected to be rendered (311,399)(c)
Total compensation cost of actual forfeited options (220,350)(d)
Total unrecognized compensation cost, end of the period, based on
actual forfeitures 8,667,100
Subtotal $ 21,888,100
Average total unrecognized compensation, based on actual forfeitures $ 10,944,050
Assumed repurchase of shares:
Repurchase shares at average market price during the year
($37,719,050 ÷ $44) 857,251
Incremental shares (892,500 – 857,251) 35,249
Computation of Diluted EPS for the Year Ended December 31, 20X7:
Net income $ 97,385,602
Weighted-average common shares outstanding 25,000,000
Incremental shares 35,249
Total shares outstanding 25,035,249
Diluted earnings per share $ 3.89
(a) Pre-tax annual share-based compensation cost is $4,022,151 [(821,406 × $14.69) ÷ 3].
(b) Share options granted at the beginning of the year plus share options outstanding at the end of the year divided by two
equals the weighted-average number of share options outstanding in 20X7: [(900,000 + 885,000) ÷ 2] = 892,500. This
example assumes that forfeitures occurred ratably throughout 20X7.
(c) 885,000 (options outstanding at December 31, 20X7) – 821,406 (options for which the requisite service is expected to be
rendered) = 63,594. 63,594 options × $14.69 (grant-date fair value per option) = $934,196 (total fair value). $934,196 ÷ 3 =
$311,399 (annual share-based compensation cost).
(d) 15,000 (forfeited options) × $14.69 (grant-date fair value per option) = $220,350 (total fair value).
449
Example 12-1
Employee Stock Options — No Exercises or Forfeitures During the Period

Assume the following about Entity A:
• Entity A has net income of $5 million, as well as 1 million common shares outstanding, for the entire year
ended December 31, 20X2.
• As of December 31, 20X2, A also has 100,000 employee stock options outstanding. All the stock options
were granted on January 1, 20X1, and vest solely on the basis of a two-year service condition. On
December 31, 20X1, 50,000 stock options vested. The remaining 50,000 stock options vest on December
31, 20X2. All options are still outstanding on December 31, 20X2 (i.e., none have been exercised).
• All the stock options have an exercise price of $10 per option and a grant-date fair-value-based measure
of $2 per option.
• Entity A recognizes compensation cost for these stock options on a straight-line basis over the service
period from January 1, 20X1, to December 31, 20X2.
• The average market price of A’s common stock for the year ended December 31, 20X2, was $15 per
share.
Entity A computes diluted EPS for the year ended December 31, 20X2, as follows:
Proceeds:
Exercise price (100,000 options × $10 per option) $ 1,000,000
Average unrecognized compensation cost {[unrecognized compensation cost at

beginning of year ($100,000) + unrecognized compensation cost at end of year
($0)] ÷ 2}* 50,000
Total hypothetical proceeds $ 1,050,000
Average market price $ 15
Number of shares reacquired ($1,050,000 hypothetical

proceeds ÷ $15 average market price) 70,000
Incremental number of shares issued (100,000 shares issued upon exercise –

70,000 shares reacquired) 30,000
Weighted-average number of common shares outstanding during the year – basic 1,000,000
Shares included in computation of diluted EPS 1,030,000
Net income available to common shareholders $ 5,000,000
Diluted EPS $ 4.85
* This is a simplified calculation. A more refined calculation may yield a different amount.
Note that in the above computation of diluted EPS, year-to-date amounts are used for simplicity. ASC 260-10-
55-3 states, in part, “For year-to-date diluted EPS, the number of incremental shares to be included in the
denominator shall be determined by computing a year-to-date weighted average of the number of incremental
shares included in each quarterly diluted EPS computation.” For example, assume that when applying the
treasury stock method, A determined that it must include 10,000 and 15,000 incremental shares in the
denominator of the calculation of diluted EPS for its first and second quarter, respectively. When computing
the number of incremental shares to include in the denominator for the year-to-date six-month period, A
would assign equal weight to the 10,000 and 15,000 incremental shares. Therefore, 12,500 incremental shares
[(10,000 + 15,000) ÷ 2] are included in the denominator of the calculation of diluted EPS for the year-to-date
six-month period.
450
The example below illustrates the application of the treasury stock method to stock option awards when
a portion of the awards was exercised during the period. Once the awards are exercised, the shares
issued are considered outstanding common shares and are included in the weighted-average number
of common shares outstanding (i.e., the denominator in the calculation of basic EPS).
Example 12-2
Employee Stock Options — Exercises During the Period

Assume the same facts as in Example 12-1, except that the 50,000 employee stock options that vested on
December 31, 20X1, were exercised on June 30, 20X2.
Entity A computes diluted EPS as follows:
Weighted-average number of stock options outstanding for the

year ended December 31, 20X2* 75,000
Proceeds:
Exercise price (75,000 weighted-average stock options outstanding × $10 per

option) $ 750,000

beginning of year ($100,000) + unrecognized compensation cost at end of year
($0)] ÷ 2}** 50,000
Total hypothetical proceeds $ 800,000
Average market price (year ended December 31, 20X2) $ 15
Number of shares reacquired ($800,000 hypothetical proceeds ÷ $15 average market

price) 53,333
Incremental number of shares issued (75,000 shares issued upon exercise – 53,333
shares reacquired) 21,667
Weighted-average number of common shares outstanding during the year – basic

[1 million shares outstanding at the beginning of the year + (50,000 options
exercised × ½ weighted for half a year)] 1,025,000
Diluted EPS $ 4.78
* Stock options outstanding at the beginning of the year (100,000) plus stock options outstanding at the end of the
year (50,000) divided by two equals the weighted-average number of stock options outstanding for the year ended
December 31, 20X2. This weighting is a simplistic average of the options at the beginning and the end of the year
because the options were exercised half way through the year. If options were exercised periodically throughout the
year, a more detailed weighting may be necessary.
** This is a simplified calculation. A more refined calculation may yield a different amount.
451
As noted in Example 12-1, the above computation of diluted EPS is a simplified annual computation that does
not take into account interim calculations of diluted EPS as required by ASC 260-10-55-3. The above calculation
is further simplified because of how exercises during the period are factored into the calculation. In the above
example, the “weighting” effect on incremental common shares for stock options exercised during the period
is factored into the calculation by weighting the number of stock options outstanding during the entire period
(i.e., one treasury stock method calculation is performed to calculate the diluted impact of all stock options). A
more precise way to factor in stock options exercised during the period is to perform two calculations under
the treasury stock method — one for stock options that were outstanding for the entire period and one for
stock options that were exercised during the period. Under this approach, the “weighting” effect on incremental
common shares for stock options exercised during the period is captured by multiplying the incremental
common shares by a factor (i.e., percentage) that is determined on the basis of the period during which the
options were outstanding.
While the more precise calculation may yield results that do not differ from those under the simplified
approach, an entity should consider its specific facts and circumstances in determining when a simplified
approach is appropriate. In some circumstances, a simplified approach could result in exclusion of the dilutive
effect of awards that were not outstanding during the entire period because of a difference between the
average stock price during the entire reporting period and the average stock price during the period in which
the awards were outstanding.
The example below illustrates the application of the treasury stock method to stock option awards when
there is a forfeiture during the period.
Example 12-3
Employee Stock Options — Forfeitures During the Period

Assume the following:
• Entity A has net income of $1 million for the quarter ended March 31, 20X1, as well as 100,000 common
shares outstanding for the entire period from January 1, 20X1, to March 31, 20X1.
• On January 1, 20X1, A granted 10,000 employee stock options to 10 employees (1,000 stock options
each).
• All the stock options have an exercise price of $5 per option and a grant-date fair-value-based measure
of $1 per option, and they cliff vest after two years of service.
• The average market price of A’s common stock for the three-month period ended March 31, 20X1, was
$6.50 per share.
• Entity A has a policy of estimating forfeitures, and it estimates that 8,000 of the stock options will
eventually vest. It therefore has accrued compensation cost on the basis of this forfeiture estimate.
• On February 1, 20X1, an employee terminates and forfeits 1,000 stock options.
452
Entity A computes the number of incremental shares to include in the denominator of the calculation of diluted
EPS under the treasury stock method, as well as diluted EPS (for the three-month period ended March 31,
20X1), as follows:
Weighted-average number of stock options outstanding for the

year ended March 31, 20X1* 9,333
Proceeds:
Exercise price (9,333 weighted-average stock options outstanding × $5 per option) $ 46,665
Average unrecognized compensation cost:
Unrecognized compensation cost at beginning of period (10,000 actual options

outstanding × $1 grant-date fair-value-based measure) $ 10,000
Unrecognized compensation cost at end of period [(9,000 actual options

outstanding × $1 grant-date fair-value-based measure) × (21 months/24
months services to be rendered)] $ 7,875
Average unrecognized compensation cost [($10,000 unrecognized compensation

cost at beginning of period + $7,875 unrecognized compensation cost at end of
period) ÷ 2] $ 8,938
Total hypothetical proceeds $ 55,603
Average market price (January 1, 20X1, to March 31, 20X1) $ 6.50
Number of shares reacquired ($55,603 hypothetical proceeds ÷

$6.50 average market price) 8,554
Incremental number of shares issued (9,333 shares issued upon exercise –

8,554 shares reacquired) 779
Weighted-average number of common shares outstanding during the year – basic 100,000
Shares included in computation of diluted EPS 100,779
Diluted EPS $ 9.92
* Stock options outstanding for the month of January (10,000) plus stock options outstanding for the month of February
(9,000) plus stock options outstanding for the month of March (9,000) divided by three equals the weighted-average
number of stock options outstanding for the quarter ended March 31, 20X1.
Note that A must base the computation of diluted EPS on the actual number of awards outstanding (i.e.,
actual forfeitures) in a given reporting period rather than on its estimate of the number of awards expected to
forfeit. In addition, note that the above calculation is simplified because of how forfeitures during the period
are factored into the calculation. In the above example, the “weighting” effect on incremental common shares
for stock options forfeited during the period is factored into the calculation by weighting the number of stock
options outstanding during the entire period (i.e., one treasury stock method calculation is performed to
calculate the diluted impact of all stock options). A more precise way to factor in stock options forfeited during
the period is to perform two calculations under the treasury stock method — one for stock options that were
outstanding for the entire period and one for stock options that were forfeited during the period. Under this
approach, the “weighting” effect on incremental common shares for stock options forfeited during the period is
captured by multiplying the incremental common shares by a factor (i.e., percentage) that is determined on the
basis of the period during which the options were outstanding.
453
While the more precise calculation may yield results that do not differ significantly from those under the
simplified approach, an entity should consider its specific facts and circumstances in determining when a
simplified approach is appropriate. In some circumstances, a simplified approach could result in exclusion
of the dilutive effect of awards that were not outstanding during the entire period because of a difference
between the average stock price during the entire reporting period and the average stock price during the
period in which the awards were outstanding.
12.4.2.2 Service Conditions
ASC 260-10
Treatment of Contingently Issuable Shares in Weighted-Average Shares Outstanding

45-12C Contractual agreements (usually associated with purchase business combinations) sometimes provide
for the issuance of additional common shares contingent upon certain conditions being met. Consistent with the
objective that basic EPS should represent a measure of the performance of an entity over a specific reporting
period, contingently issuable shares should be included in basic EPS only when there is no circumstance under
which those shares would not be issued and basic EPS should not be restated for changed circumstances.
45-13 Shares issuable for little or no cash consideration upon the satisfaction of certain conditions
(contingently issuable shares) shall be considered outstanding common shares and included in the
computation of basic EPS as of the date that all necessary conditions have been satisfied (in essence,
when issuance of the shares is no longer contingent). Outstanding common shares that are contingently
returnable (that is, subject to recall) shall be treated in the same manner as contingently issuable shares. Thus,
contingently issuable shares include shares that meet any of the following criteria:
a. They will be issued in the future upon the satisfaction of specified conditions.
b. They have been placed in escrow and all or part must be returned if specified conditions are not met.
c. They have been issued but the holder must return all or part if specified conditions are not met.

45-32 Fixed grantee stock options (fixed awards) and nonvested stock (including restricted stock) shall be
included in the computation of diluted EPS based on the provisions for options and warrants in paragraphs
260-10-45-22 through 45-27. Even though their issuance may be contingent upon vesting, they shall not be
considered to be contingently issuable shares (see Section 815-15-55 and paragraph 260-10-45-48). However,
because issuance of performance-based stock options (and performance-based nonvested stock) is contingent
upon satisfying conditions in addition to the mere passage of time, those options and nonvested stock shall be
considered to be contingently issuable shares in the computation of diluted EPS. A distinction shall be made
only between time-related contingencies and contingencies requiring specific achievement.
Generally, an entity will use the treasury stock method to determine the number of common shares
related to share-based payment awards with only a service condition (i.e., no performance or market
condition) to include in the denominator of the calculation of diluted EPS provided that the awards are
dilutive. (See Section 12.4.2.1.5 for examples illustrating the application of the treasury stock method to
share-based payment awards.)
In the computation of basic EPS, a restricted stock award is not included in the denominator of the
calculation of basic EPS during the employee’s requisite service period or before the nonemployee
award has vested, even if the shares of stock have been legally issued. Such shares are considered
contingently returnable shares as described in ASC 260-10-45-13. For example, if the grantee does
not deliver the good or render the service, the shares are returned to the entity. Once the vesting
conditions have been satisfied, the shares are considered outstanding common shares and therefore
454
are included in the weighted-average number of common shares outstanding (i.e., the denominator in
the computation of basic EPS).
In addition, an unexercised stock option award is not included in the denominator of the calculation of
basic EPS even if the award is vested. That is, even if an award’s vesting conditions have been satisfied,
an unexercised stock option is not an outstanding common share until it is exercised.
However, an award that contains a right to nonforfeitable dividends or dividend equivalents that
participate in undistributed earnings with common stock is a participating security even before the
award’s vesting conditions are satisfied (i.e., during the vesting period). Therefore, the issuer is required
to apply the two-class method discussed in Section 12.4.3 when computing basic and diluted EPS. When
computing diluted EPS for unvested awards that are considered participating securities, an entity must
determine which is more dilutive to apply, the treasury stock method or the two-class method.
In the computation of diluted EPS, unvested awards and unexercised stock option awards that vest
solely on the basis of a service condition are included in the denominator of the calculation of diluted
EPS during their requisite service period (or before the nonemployee award has vested) or during
the period the options are unexercised under the treasury stock method. (See Section 12.4.2.1 for a
discussion of the application of the treasury stock method to share-based payment awards.)
12.4.2.3 Performance and Market Conditions

ASC 260-10
45-31 Awards with a market condition, a performance condition, or any combination thereof (as defined in
Topic 718) shall be included in diluted EPS pursuant to the contingent share provisions in paragraphs 260-10-
45-48 through 45-57.
45-32 Fixed grantee stock options (fixed awards) and nonvested stock (including restricted stock) shall be
included in the computation of diluted EPS based on the provisions for options and warrants in paragraphs
260-10-45-22 through 45-27. Even though their issuance may be contingent upon vesting, they shall not be
considered to be contingently issuable shares (see Section 815-15-55 and paragraph 260-10-45-48). However,
because issuance of performance-based stock options (and performance-based nonvested stock) is contingent
upon satisfying conditions in addition to the mere passage of time, those options and nonvested stock shall be
considered to be contingently issuable shares in the computation of diluted EPS. A distinction shall be made
only between time-related contingencies and contingencies requiring specific achievement.
Contingently Issuable Shares

45-48 Shares whose issuance is contingent upon the satisfaction of certain conditions shall be considered
outstanding and included in the computation of diluted EPS as follows:
a. If all necessary conditions have been satisfied by the end of the period (the events have occurred), those
shares shall be included as of the beginning of the period in which the conditions were satisfied (or as of
the date of the contingent stock agreement, if later).
b. If all necessary conditions have not been satisfied by the end of the period, the number of contingently
issuable shares included in diluted EPS shall be based on the number of shares, if any, that would be
issuable if the end of the reporting period were the end of the contingency period (for example, the
number of shares that would be issuable based on current period earnings or period-end market
price) and if the result would be dilutive. Those contingently issuable shares shall be included in the
denominator of diluted EPS as of the beginning of the period (or as of the date of the contingent stock
agreement, if later).
45-49 For year-to-date computations, contingent shares shall be included on a weighted-average basis. That is,
contingent shares shall be weighted for the interim periods in which they were included in the computation of
diluted EPS.
455
45-50 Paragraphs 260-10-45-51 through 45-54 provide general guidelines that shall be applied in determining
the EPS impact of different types of contingencies that may be included in contingent stock agreements.
45-55 Contingently issuable potential common shares (other than those covered by a contingent stock
agreement, such as contingently issuable convertible securities) shall be included in diluted EPS as follows:
a. An entity shall determine whether the potential common shares may be assumed to be issuable based
on the conditions specified for their issuance pursuant to the contingent share provisions in paragraphs
260-10-45-48 through 45-54.
b. If those potential common shares should be reflected in diluted EPS, an entity shall determine their
impact on the computation of diluted EPS by following the provisions for options and warrants in
paragraphs 260-10-45-22 through 45-37, the provisions for convertible securities in paragraphs 260-10-
45-40 through 45-42, and the provisions for contracts that may be settled in stock or cash in paragraph
260-10-45-45, as appropriate.
For share-based payment awards with a performance or market condition, an entity must first apply the
guidance on contingently issuable shares in ASC 260-10-45-48 through 45-55 to determine whether
the awards should be included in the computation of diluted EPS for the reporting period. That is, for
all outstanding performance- and market-based awards, the entity needs to determine the number of
shares, if any, that would be issuable at the end of the reporting period if the end of the reporting period
were the end of the contingency period (e.g., the number of shares that would be issued on the basis of
current-period earnings or the period-end market price). Once the entity has determined that the award
should be included in the computation of diluted EPS for the reporting period, the entity must use the
treasury stock method to determine the number of incremental shares to include in the denominator of
the calculation of diluted EPS.
An entity may be recording compensation cost for an award that only contains a performance or
market condition because the entity believes that it is probable that the award will vest (performance
condition) or, for example, that the employee will remain employed for the derived service period
(market condition). However, in such cases, the incremental shares that would be included in the
denominator of the calculation of diluted EPS would be excluded if the performance or market condition
(i.e., the contingency) has not been achieved as of the end of that particular reporting period, under an
assumption that the end of the reporting period is the end of the contingency period.
12.4.2.3.1 Performance-Based Awards

ASC 260-10
45-51 If attainment or maintenance of a specified amount of earnings is the condition and if that amount
has been attained, the additional shares shall be considered to be outstanding for the purpose of computing
diluted EPS if the effect is dilutive. The diluted EPS computation shall include those shares that would be issued
under the conditions of the contract based on the assumption that the current amount of earnings will remain
unchanged until the end of the agreement, but only if the effect would be dilutive. Because the amount of
earnings may change in a future period, basic EPS shall not include such contingently issuable shares because
all necessary conditions have not been satisfied. Example 3 (see paragraph 260-10-55-53) illustrates that
provision.
45-54 If the contingency is based on a condition other than earnings or market price (for example, opening
a certain number of retail stores), the contingent shares shall be included in the computation of diluted EPS
based on the assumption that the current status of the condition will remain unchanged until the end of the
contingency period. Example 3 (see paragraph 260-10-55-53) illustrates that provision.
456
Assume that a stock award legally vests only if an entity’s cumulative net income at the end of the third
annual reporting period exceeds $10 million. At the end of each reporting period, the entity assesses
whether cumulative net income has exceeded $10 million as if that reporting date were the end of the
third annual reporting period. If the performance condition has been met at the end of a reporting
period, the entity includes the award in the computation of diluted EPS. To determine the number of
incremental shares of stock to include in the denominator of the calculation of diluted EPS, the entity
applies the treasury stock method if the effect is dilutive on the basis of the antidilution sequencing
However, if the entity’s cumulative net income has not exceeded $10 million at the end of the reporting
period, the entity does not include the award in the computation of diluted EPS even if it is recording
compensation cost because it believes that it is probable that the award will vest (i.e., it is probable that
the performance target will be achieved). The entity excludes the award from the calculation of diluted
EPS because the performance condition (i.e., the contingency) has not been met as of the end of that
reporting period.
Example 12-4
Calculating Diluted EPS When Vesting of Stock Options Is Contingent on Future Earnings
Assume the following:
• Entity A has net income of $12 million and $5 million for the year and quarter ended December 31, 20X1,
respectively, as well as 5 million common shares outstanding for the quarter ended December 31, 20X1.
• On January 1, 20X1, A granted 1 million employee stock options. The stock options vest on December 31,
20X2, if the recipients remain employed and A’s cumulative net income for the two-year period ended
December 31, 20X2, equals or exceeds $10 million.
• As of December 31, 20X1, all the stock options remain outstanding.
• The stock options have an exercise price of $10 per option and a grant-date fair-value-based measure of
$2 per option.
• The average market price of A’s common stock for the year ended December 31, 20X1, was $15 per
share.
If the end of the reporting period (December 31, 20X1) is considered the end of the contingency period,
the performance target is deemed to be achieved. As a result, A includes the employee stock options in the
calculation of diluted EPS for the quarter ended December 31, 20X1. To determine the number of incremental
shares to include in the calculation’s denominator, A must then apply the treasury stock method if the effect is
dilutive.
457
Entity A computes diluted EPS under the treasury stock method for the quarterly period ended December 31,
20X1, as follows:
Shares to be issued upon exercise of employee stock options outstanding as of

December 31, 20X1 1,000,000
Proceeds:
Exercise price (1,000,000 options × $10 per option) $ 10,000,000

beginning of quarter ($1,250,000) + unrecognized compensation cost at end of
quarter ($1,000,000)] ÷ 2} 1,125,000
Total hypothetical proceeds $ 11,125,000
Average market price $ 15
Number of shares reacquired ($11,125,000 hypothetical

proceeds ÷ $15 average market price) 741,667
Incremental number of shares issued (1,000,000 shares issued upon exercise –

741,667 shares reacquired) 258,333
Weighted-average number of common shares outstanding during the quarter – basic 5,000,000
Diluted EPS $ 0.95
Alternatively, assume that A had generated net income of less than $10 million for the year ended December
31, 20X1. In that case, A excludes the employee stock options from the computation of diluted EPS because
the contingency is not deemed to have been met as of the end of the reporting period. Therefore, A is not
required to determine the number of incremental shares to include in the denominator of the calculation of
diluted EPS under the treasury stock method. However, if A believes that it is probable that the performance
target will be attained by the end of the performance period (December 31, 20X2), A recognizes compensation
cost over the requisite service period for the number of awards expected to vest.
There may be other circumstances in which an entity issues performance-based awards for which
performance is calculated on the basis of an average metric over several periods. When calculating
whether contingently issuable shares for such awards should be included in the computation of diluted
EPS, an entity applies ASC 260-10-45-51 and ASC 260-10-45-54, which require the entity to assume that
the current status of the condition (e.g., the current amount of earnings) will remain unchanged until the
end of the contingency period. In addition, footnote (f) to Example 3 in ASC 260-10-55-56 states, in part,
that “[p]rojecting future earnings levels and including the related contingent shares are not permitted.”
While footnote (f) to Example 3 is associated with the computation of diluted EPS for an interim period,
we believe that it is appropriate to apply the guidance to both interim and annual periods. Because
the guidance precludes the projection of future earnings levels, earnings (or any other metric) in future
periods would be presumed to be zero. See further discussion in Section 4.5.2.3 of Deloitte’s Roadmap
Earnings per Share. See also the example below.
458
Example 12-4A
Calculating Diluted EPS for an Award That Vests on the Basis of Average Metrics
On January 1, 20X1, Entity A granted 1 million performance-based RSUs to a group of its key employees. The
RSUs cliff vest on December 31, 20X3, if the recipients remain employed and A achieves two performance
metrics during the three-year period from January 20X1 to December 20X3: (1) a three-year average revenue
growth rate of at least 10 percent and (2) a three-year average operating margin of at least 6 percent.
The number of contingently issuable shares that are included in the calculation of diluted EPS is determined
on the basis of the three-year averages of both the revenue growth rate and operating margins, which are
calculated as follows: (1) the actual revenue growth rate and operating margin attained to date and (2) an
assumption of zero revenue growth rate and zero operating margin for any remaining periods.
Revenue Growth Rate Operating Margin
20X1 12% 6%
20X2 9% 6%
20X3 12% 9%
Entity A determines the number of shares to include in the calculation of diluted EPS by using the following
assumptions:
December 31, 20X1

No shares are included in the calculation of diluted EPS because:
• The three-year average revenue growth rate of 4 percent [(12% for 20X1 + 0% for 20X2 + 0% for 20X3) ÷
3 years] is below 10 percent.
• The three-year average operating margin of 2 percent [(6% for 20X1 + 0% for 20X2 + 0% for 20X3) ÷ 3
years] is below 6 percent.
December 31, 20X2
No shares are included in the calculation of diluted EPS because:
• The three-year average revenue growth rate of 7 percent [(12% for 20X1 + 9% for 20X2 + 0% for 20X3) ÷
3 years] is below 10 percent.
years] is below 6 percent.
December 31, 20X3
The 1 million shares are included in the calculation of diluted EPS because:
• The three-year average revenue growth rate of 11 percent [(12% for 20X1 + 9% for 20X2 + 12% for 20X3)
÷ 3 years] is above 10 percent.
years] is above 6 percent.
As noted in Example 12-1, in the above example, year-to-date amounts are used for simplicity.
459
12.4.2.3.2 Market-Based Awards
ASC 260-10
45-52 The number of shares contingently issuable may depend on the market price of the stock at a future
date. In that case, computations of diluted EPS shall reflect the number of shares that would be issued based
on the current market price at the end of the period being reported on if the effect is dilutive. If the condition
is based on an average of market prices over some period of time, the average for that period shall be used.
Because the market price may change in a future period, basic EPS shall not include such contingently issuable
shares because all necessary conditions have not been satisfied.
45-53 In some cases, the number of shares contingently issuable may depend on both future earnings and
future prices of the shares. In that case, the determination of the number of shares included in diluted EPS
shall be based on both conditions, that is, earnings to date and current market price — as they exist at the end
of each reporting period. If both conditions are not met at the end of the reporting period, no contingently
issuable shares shall be included in diluted EPS.
Assume that an award legally vests only if the entity’s share price increases by more than 20 percent
after the grant date. At the end of each reporting period, the entity would assess whether its share price
has, in fact, increased by more than 20 percent after the grant date. If, at the end of a reporting period,
the market condition has been met, the entity includes the award in the computation of diluted EPS. To
determine the number of incremental shares to include in the denominator of the calculation of diluted
EPS, the entity applies the treasury stock method if the effect is dilutive on the basis of the antidilution
sequencing requirements of ASC 260.
However, if the entity’s share price has not increased by more than 20 percent at the end of the
reporting period, the award is not included in the computation of diluted EPS even if the entity
is recording compensation cost because it believes that, for example, the employee will remain
employed for the derived service period. The award is excluded because the market condition (i.e., the
contingency) has not been met as of the end of that reporting period. Moreover, if an employee does
remain employed for the derived service period, the employee is deemed to have earned (i.e., vested
in) the award. In this circumstance, the entity will not reverse any previously recognized compensation
cost even if the market condition is never satisfied. If the market condition is never satisfied, the shares
issuable under the award will never become issued and outstanding. Therefore, the shares will never be
included in the weighted-average number of common shares (i.e., the denominator in the calculation of
basic and diluted EPS).
12.4.3 Participating Securities and the Two-Class Method

ASC 260-10
Participating Securities and the Two-Class Method

45-59A The capital structures of some entities include:
a. Securities that may participate in dividends with common stocks according to a predetermined formula
(for example, two for one) with, at times, an upper limit on the extent of participation (for example, up to,
but not beyond, a specified amount per share)
b. A class of common stock with different dividend rates from those of another class of common stock but
without prior or senior rights.
460
45-60 The two-class method is an earnings allocation formula that treats a participating security as having
rights to earnings that otherwise would have been available to common shareholders but does not require the
presentation of basic and diluted EPS for securities other than common stock. The presentation of basic and
diluted EPS for a participating security other than common stock is not precluded.
45-60A All securities that meet the definition of a participating security, irrespective of whether the securities
are convertible, nonconvertible, or potential common stock securities, shall be included in the computation of
basic EPS using the two-class method.
45-60B Under the two-class method:

a. Income from continuing operations (or net income) shall be reduced by the amount of dividends
declared in the current period for each class of stock and by the contractual amount of dividends (or
interest on participating income bonds) that must be paid for the current period (for example, unpaid
cumulative dividends). Dividends declared in the current period do not include dividends declared
in respect of prior-year unpaid cumulative dividends. Preferred dividends that are cumulative only if
earned are deducted only to the extent that they are earned.
b. The remaining earnings shall be allocated to common stock and participating securities to the extent
that each security may share in earnings as if all of the earnings for the period had been distributed. The
total earnings allocated to each security shall be determined by adding together the amount allocated
for dividends and the amount allocated for a participation feature.
c. The total earnings allocated to each security shall be divided by the number of outstanding shares of the
security to which the earnings are allocated to determine the EPS for the security.
d. Basic and diluted EPS data shall be presented for each class of common stock.
For the diluted EPS computation, outstanding common shares shall include all potential common shares
assumed issued. Example 6 (see paragraph 260-10-55-62) illustrates the two-class method.
45-61 Fully vested share-based compensation subject to the provisions of Topic 718, including fully vested
options and fully vested stock, that contain a right to receive dividends declared on the common stock of the
issuer, are subject to the guidance in paragraph 260-10-45-60A.
45-61A Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend
equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of
EPS pursuant to the two-class method under the requirements of paragraph 260-10-45-60A.
45-62 Dividends or dividend equivalents transferred to the holder of a convertible security in the form of
a reduction to the conversion price or an increase in the conversion ratio of the security do not represent
participation rights. This guidance applies similarly to other contracts (securities) to issue an entity’s common
stock if these contracts (securities) provide for an adjustment to the exercise price that is tied to the declaration
of dividends by the issuer. The scope of the guidance in this paragraph excludes forward contracts to issue an
entity’s own equity shares.
45-63 In a forward contract to issue an entity’s own equity shares, a provision that reduces the contract price
per share when dividends are declared on the issuing entity’s common stock represents a participation right.
Such a provision constitutes a participation right because it results in a noncontingent transfer of value to the
holder of the forward contract for dividends declared during the forward contract period. That is, the forward
contract holder has a right to participate in the undistributed earnings of the issuing entity because a dividend
declaration by the issuing entity results in a transfer of value to the holder of the forward contract through a
reduction in the forward purchase price per share. Because that value transfer is not contingent — as opposed
to a similar reduction in the exercise price of an option or warrant — the forward contract is a participating
security, regardless of whether, during the period the contract is outstanding, a dividend is declared.
461
45-64 A dividend equivalent that is applied to reduce the conversion price or increase the conversion ratio of
a convertible security may represent a contingent beneficial conversion feature. Guidance on whether such
a dividend equivalent represents a contingent beneficial conversion feature is presented in Subtopic 470-20.
That Subtopic also establishes the accounting required for contingent beneficial conversion features.
45-65 Undistributed earnings for a period shall be allocated to a participating security based on the contractual
participation rights of the security to share in those current earnings as if all of the earnings for the period
had been distributed. If the terms of the participating security do not specify objectively determinable,
nondiscretionary participation rights, then undistributed earnings would not be allocated based on arbitrary
assumptions. For example, if an entity could avoid distribution of earnings to a participating security, even if all
of the earnings for the year were distributed, then no allocation of that period’s earnings to the participating
security would be made. Paragraphs 260-10-55-24 through 55-31 provide additional guidance on participating
securities and undistributed earnings.
45-66 Under the two-class method the remaining earnings shall be allocated to common stock and
participating securities to the extent that each security may share in earnings as if all of the earnings for the
period had been distributed. This allocation is required despite its pro forma nature and that it may not reflect
the economic probabilities of actual distributions to the participating security holders.
45-67 An entity would allocate losses to a nonconvertible participating security in periods of net loss if, based
on the contractual terms of the participating security, the security had not only the right to participate in the
earnings of the issuer, but also a contractual obligation to share in the losses of the issuing entity on a basis
that was objectively determinable. Determination of whether a participating security holder has an obligation to
share in the losses of the issuing entity in a given period shall be made on a period-by-period basis, based on
the contractual rights and obligations of the participating security. The holder of a participating security would
have a contractual obligation to share in the losses of the issuing entity if either of the following conditions is
present:
a. The holder is obligated to fund the losses of the issuing entity (that is, the holder is obligated to transfer
assets to the issuer in excess of the holder’s initial investment in the participating security without any
corresponding increase in the holder’s investment interest).
b. The contractual principal or mandatory redemption amount of the participating security is reduced as a
result of losses incurred by the issuing entity.
45-68 A convertible participating security should be included in the computation of basic EPS in periods of
net loss if, based on its contractual terms, the convertible participating security has the contractual obligation
to share in the losses of the issuing entity on a basis that is objectively determinable. The guidance in this
paragraph also applies to the inclusion of convertible participating securities in basic EPS, irrespective of the
differences that may exist between convertible and nonconvertible securities. That is, an entity should not
automatically exclude a convertible participating security from the computation of basic EPS if an entity has a
net loss from continuing operations. Determination of whether a participating security holder has an obligation
to share in the losses of the issuing entity in a given period shall be made on a period-by-period basis, based
on the contractual rights and obligations of the participating security.
45-68A Paragraph not used.
462
45-68B Paragraph 718-10-55-45 requires that nonrefundable dividends or dividend equivalents paid on
awards for which the requisite service is not (or is not expected to be) rendered be recognized as additional
compensation cost and that dividends or dividend equivalents paid on awards for which the requisite service
is (or is expected to be) rendered be charged to retained earnings. As a result, an entity shall not include
dividends or dividend equivalents that are accounted for as compensation cost in the earnings allocation
in computing EPS. To do so would include the dividend as a reduction of earnings available to common
shareholders from both compensation cost and distributed earnings. Undistributed earnings shall be allocated
to all share-based payment awards outstanding during the period, including those for which the requisite
service is not expected to be rendered (or is not rendered because of forfeiture during the period, if an entity
elects to account for forfeitures when they occur in accordance with paragraph 718-10-35-3). An entity’s
estimate of the number of awards for which the requisite service is not expected to be rendered (or no
estimate, if the entity has elected to account for forfeitures when they occur in accordance with paragraph
718-10-35-3) for the purpose of determining EPS under this Topic shall be consistent with the estimate used
for the purposes of recognizing compensation cost under Topic 718. Paragraph 718-10-35-3 requires that an
entity apply a change in the estimate of the number of awards for which the requisite service is not expected
to be rendered in the period that the change in estimate occurs. This change in estimate will affect net income
in the current period; however, a current-period change in an entity’s expected forfeiture rate would not affect
prior-period EPS calculations. See Example 9 for an illustration of this guidance.
45-70 See Example 9 (paragraph 260-10-55-71) for an illustration of this guidance.
Entities are required to use the two-class method to calculate basic and diluted EPS if their capital
structure includes common stock and either (1) participating securities or (2) common stock with a
different dividend rate.
12.4.3.1 Participating Securities
Provided that an instrument’s participation feature is nondiscretionary and objectively determinable, the
instrument’s classification as a participating security depends on the participation mechanism and the
nature of the participating instrument. The table below describes the classification of some common
instruments.
Is the Instrument a
Instrument Form of “Participation” Participating Security?
Debt and preferred stock, Potential participation is paid in Yes

convertible and nonconvertible cash (or the contractual maturity
amount is increased) according
to a formula tied to dividends on
common stock
Preferred stock Holders of preferred stock are No

entitled to receive a current-period
dividend before holders of common
stock can be paid dividends
Convertible debt and preferred Potential participation is achieved No

stock through a reduction of the
conversion price, an increase in the
conversion ratio, or an increase in
the liquidation preference
463
(Table continued)
Is the Instrument a
Instrument Form of “Participation” Participating Security?
Options or warrants to sell Potential participation is paid in Yes

common stock cash according to a formula tied to
dividends on common stock
Options or warrants to sell Potential participation is achieved No

common stock through a reduction of the exercise
price or an increase in the number
of shares upon exercise
Forward contract to sell common Participation is achieved through a A facts-and-circumstances analysis

stock reduction of the forward price or an must be performed
increase in the number of shares
under the forward contract
Forward contract to sell common A formula that adjusts the forward A facts-and-circumstances analysis
stock price and the number of shares must be performed
under the forward contract,
depending on the market price of
the stock as of the date the forward
contract is settled
Participation does not need to be in the form of a dividend. Any participation by a security in the
distribution of a company’s earnings (under an assumption that there is a full distribution of earnings)
would constitute participation, regardless of whether a cash payment is, or would be accounted for as, a
dividend.
Example 12-5
Warrants on Common Stock With Yield Rights

Entity J issues warrants to sell common stock that entitle the counterparty to a yield right, payable in cash, equal
to 25 percent of the dividends J pays on its common stock for each common share into which the warrants are
exercisable. Although the yield right is not labeled as a dividend, it is a participation right because the holder
of the warrants is entitled to share in dividends declared on J’s common stock without exercising the warrants.
Therefore, the two-class method of calculating EPS must be applied to the warrants. Regardless of whether J
declared any dividends during the period, it must allocate undistributed earnings to the warrants.
Note that in this example, the warrants are considered participating securities regardless of the extent of
participation. That is, because of the holders’ entitlement to any participation in dividends (i.e., between 1 and
100 percent), the warrants meet the definition of a participating security. However, if dividends paid by an entity
are held in abeyance and paid to a warrant holder only upon exercise, such warrants would not be considered
participating securities.
12.4.3.1.1 Dividend-Paying Share-Based Payment Awards — Before Vesting

An award is a participating security if, during the vesting period, it contains a nonforfeitable right
to dividends or dividend equivalents that participate in the distribution of earnings with common
stock. That is, an award is considered a participating security if it accrues cash dividends (whether
paid or unpaid) any time the common shareholders receive dividends — when those dividends do
not need to be returned to an entity if the grantee forfeits the awards. The entity is required to apply
the two-class method when computing basic and diluted EPS. By contrast, if the right to dividends
or dividend equivalents is forfeitable with the underlying award, the award is not considered a
participating security.
464
12.4.3.1.2 Dividend-Paying Share-Based Payment Awards — After Vesting

ASC 260-10-45-61 states:
Fully vested stock-based compensation subject to the provisions of Topic 718, including fully vested options
and fully vested stock, that contain a right to receive dividends declared on the common stock of the issuer, are
subject to the guidance in paragraph 260-10-45-60A.
After an award has vested, it is a participating security if it contains a right to receive dividends or
dividend equivalents with common shareholders, because the right is nonforfeitable when the award
vests. Therefore, an entity must apply the two-class method when computing basic and diluted EPS
unless the shares become outstanding common shares. For example, the two-class method does not
apply to a restricted stock award after a grantee receives outstanding common shares because the
good has been delivered or the service has been rendered. Once the award becomes outstanding
common shares, the entity includes those shares in the weighted-average number of common shares
outstanding (i.e., the denominator in the calculation of basic EPS).
12.4.3.2 Computation Under the Two-Class Method

Under the two-class method, an entity uses the following three-step process to calculate basic and
diluted EPS:
Step 1 Use the two-class method to compute basic EPS. As indicated in ASC 260-10-45-60, “[t]he
two-class method is an earnings allocation formula that treats a participating security as having
rights to earnings that otherwise would have been available to common shareholders.” 2
Step 2 Determine diluted EPS. Use the total earnings allocated to the common stock in step 1 to
determine diluted EPS. If the participating security is also a potential common share, separately
perform steps 2a and 2b to determine the dilutive effect.
Step 2a Use the treasury stock method, the if-converted method, or the contingently issuable
share method to determine diluted EPS. Assume that the participating security has been
exercised, converted, or issued.
Step 2b Use the two-class method to determine diluted EPS. Add back the undistributed earnings
allocated to the participating security (or securities) in arriving at basic EPS, and assume that all
other dilutive potential common shares have been exercised, converted, or issued in the order in
which they are antidilutive. Next, reallocate the undistributed earnings, including any additional
income that would result from the exercise, conversion, or issuance of potential common shares, to
the (1) common shares and potential common shares and (2) participating security (or securities).
Step 3 Determine which step — 2a or 2b — results in the more dilutive effect.
While an entity is required to present on the face of the income statement basic and diluted EPS for
its common stock, the entity is permitted, but not required, to present basic and diluted EPS for a
participating security.
2
Undistributed losses would generally not be allocated to share-based payment awards in accordance with ASC 260-10-45-67 because such
awards typically would not have a “contractual obligation to share in the losses of the issuing entity on a basis that was objectively determinable.”
See Example 6 in ASC 260-10-55-62 and 55-63 for an illustration of the use of the two-class method for calculating basic EPS.
465
The examples below illustrate (1) the calculation of basic and diluted EPS under the two-class method
and (2) the use of this three-step process to determine diluted EPS.
Example 12-6
Use of the Two-Class Method to Calculate Basic and Diluted EPS — Participating Convertible
Preferred Stock
Assume that Entity A has 1 million weighted-average shares of common stock outstanding for the fiscal year
ended December 31, 20X1; a current-period net income of $5 million; and an effective tax rate of 40 percent.
On January 1, 20X1, A issues 100,000 convertible preferred securities. Each preferred share is convertible into
two shares of A’s common stock. The preferred shareholders are entitled to a noncumulative annual dividend
of $5 per share before any dividend is paid to the common shareholders. After the common shareholders
are paid a dividend of $2 per share, the preferred shareholders participate in any remaining undistributed
earnings on a 40:60 per-share basis with the common shareholders. Accordingly, the preferred securities are
participating securities for which A must use the two-class method to calculate basic and diluted EPS. In fiscal
year 20X1, A declares and pays $2.5 million in dividends (or a $5 dividend for preferred shareholders and a
$2 dividend for common shareholders).
The calculations under the two-class method are as follows:
Step 1 — Use the two-class method to compute basic EPS.
Net income $ 5,000,000
Less: dividends to preferred shareholders 500,000*
Net income available to common shareholders 4,500,000
Less: dividends to common shareholders 2,000,000*
Undistributed earnings $ 2,500,000

* The dividends would be based on the number of shares of common stock and preferred
stock outstanding as of the declaration date. For simplicity, the weighted-average and
the shares outstanding are assumed to be consistent.
Allocation of undistributed earnings:
To participating convertible preferred shares:
{(0.4 × 100,000 preferred shares*) ÷ [(0.4 × 100,000 preferred shares*) + (0.6 × 1,000,000
common shares**)]} × $2,500,000 undistributed earnings*** = $156,250
$156,250 ÷ 100,000 preferred shares* = $1.56 per share
To common shares:
{(0.6 × 1,000,000 common shares**) ÷ [(0.4 × 100,000 preferred shares*) + (0.6 × 1,000,000
common shares**)]} × $2,500,000 undistributed earnings*** = $2,343,750
$2,343,750 ÷ 1,000,000 common shares** = $2.34 per share

* Weighted-average number of participating convertible preferred shares outstanding.
** Weighted-average number of common shares outstanding.
*** Total undistributed earnings for the period.
466
Basic EPS amounts:
Participating
Convertible
Preferred
Common Shares Shares
Distributed earnings $ 2.00 $ 5.00
Undistributed earnings 2.34 1.56
Total $ 4.34 $ 6.56
Step 2 — Determine diluted EPS.

Step 2a — Use the treasury stock method, the if-converted method, or the contingently issuable share method to
determine diluted EPS.
Determine the antidilution sequencing:
Since there are no potential common shares other than the participating convertible preferred shares, A
determines that antidilution sequencing is not required.
Calculation of diluted EPS for the common shares in which the use of the if-converted method for the
participating convertible preferred shares is assumed:
Distributed/ Weighted-Average
Undistributed Number of
Earnings Common Shares
(Numerator) (Denominator) EPS
As reported, basic $ 4,343,750* 1,000,000 $ 4.34
Convertible preferred 656,250** 200,000*** —
Diluted EPS $ 5,000,000 1,200,000 $ 4.17

* Amount represents the aggregate of the distributed earnings ($2,000,000) and undistributed earnings
($2,343,750) allocated to the common shareholders.
** Amount represents the aggregate of the distributed earnings ($500,000) and undistributed earnings ($156,250)
allocated to the participating convertible preferred shares.
*** Number of common shares that would be issued upon conversion of the participating convertible preferred
shares.
Step 2b — Use the two-class method to determine diluted EPS.

Because A’s capital structure only includes common shares and participating convertible preferred shares (i.e.,
there are no other potential common shares), basic and diluted EPS would be the same under the two-class
method ($4.34).
Step 3 — Determine which step — 2a or 2b — results in the more dilutive effect.

In this example, A would disclose an amount of diluted EPS per common share that would result from applying
the if-converted method ($4.17) because that amount is more dilutive than the amount that would result from
applying the two-class method ($4.34). In accordance with ASC 260-10-45-60, A would be permitted, but not
required, to present basic and diluted EPS for the participating convertible preferred shares on the face of the
income statement.
467
Example 12-7
Use of the Two-Class Method to Calculate Basic and Diluted EPS — Participating Convertible
Preferred Stock With Convertible Debt and Warrants
Assume that Entity B has 1 million weighted-average common shares stock outstanding for the fiscal year
On January 1, 20X1, B issues 100,000 convertible preferred securities. Each preferred share is convertible into
two shares of B’s common stock. The preferred shareholders are entitled to a noncumulative annual dividend
of $5 per share before any dividend is paid to the common shareholders. After the common shareholders
are paid a dividend of $2 per share, the preferred shareholders participate in any remaining undistributed
earnings on a 40:60 per-share basis with the common shareholders. Accordingly, the preferred securities are
participating securities for which B must use the two-class method to calculate basic and diluted EPS. In fiscal
year 20X1, B declares and pays $2.5 million in dividends (or a $5 dividend for preferred shareholders and a $2
dividend for common shareholders).
In addition, assume the following:
• On January 1, 20X1, B issues warrants to purchase 100,000 shares of its common stock at $50 per share
for a period of five years. The average market price of B’s stock price for 20X1 was $60 per share. The
warrants do not meet the definition of a participating security.
• On January 1, 20X1, B issues 10,000 units of convertible bonds with an aggregate par value of $1 million.
Each bond is convertible into 10 shares of B’s common stock and bears an interest rate of 3 percent. The
convertible bonds do not meet the definition of a participating security.
The calculations under the two-class method are as follows:

Less: dividends to preferred shareholders 500,000*
Net income available to common shareholders 4,500,000
Less: dividends to common shareholders 2,000,000*
* The dividends would be based on the number of shares of common

stock and preferred stock outstanding as of the declaration date.
For simplicity, the weighted average and the shares outstanding are
assumed to be consistent.

To participating convertible preferred shares:
{(0.4 × 100,000 preferred shares*) ÷ [(0.4 × 100,000 preferred shares*) + (0.6 × 1,000,000 common
shares**)]} × $2,500,000 undistributed earnings*** = $156,250
$156,250 ÷ 100,000 preferred shares* = $1.56 per share
To common shares:
{(0.6 × 1,000,000 common shares**) ÷ [(0.4 × 100,000 preferred shares*) + (0.6 × 1,000,000 common
shares**)]} × $2,500,000 undistributed earnings*** = $2,343,750
* Weighted-average number of participating convertible preferred shares outstanding.

468
Basic EPS amounts:
Participating
Convertible
Common Preferred
Shares Shares
Total $ 4.34 $ 6.56
This calculation is the same as the calculation of basic EPS in Example 12-6, because basic EPS is not affected
by the warrants and convertible debt since neither security is a participating security.

Increase in
Earnings Available Increase in Earnings per
to Common Number of Incremental
Shareholders Common Shares Share
Warrants $ — 16,667* $ —
Convertible bonds $ 18,000** 100,000** $ 0.18
Participating convertible
preferred shares $ 656,250*** 200,000† $ 3.28
* Amount represents the incremental number of common shares for the assumed exercise of the warrants [($60
average market price – $50 exercise price) × 100,000 warrants] ÷ $60 average market price = 16,667.
** Assumed conversion of the convertible bonds would result in 100,000 incremental common shares and
the add-back of $18,000 [$1,000,000 × 3% interest rate × (1 – 40% tax rate)] in after-tax interest expense to
undistributed earnings for the period.
*** Amount represents the aggregate of the distributed earnings ($500,000) and undistributed earnings ($156,250)
† Number of common shares that would be issued upon conversion of the participating convertible preferred
shares.
469
Calculation of diluted EPS for the common shares in which the use of the if-converted method for the
participating convertible preferred shares is assumed:
As reported, basic $ 4,343,750 1,000,000 $ 4.34
Warrants — 16,667* —
$ 4,343,750 1,016,667 $ 4.27
Convertible bonds 18,000** 100,000** —
$ 4,361,750 1,116,667 $ 3.91
Participating convertible preferred 656,250*** 200,000† —
Diluted EPS $ 5,018,000 1,316,667 $ 3.81

average market price – $50 exercise price) × 100,000] ÷ $60 average market price = 16,667.
† Number of common shares that would be issued upon conversion of the participating convertible preferred
shares.
470
Add back: undistributed earnings

allocated to the participating
convertible preferred shares 156,250 — —
Warrants — 16,667* —
Less: undistributed earnings

reallocated to participating
convertible preferred shares (153,846)** —
Subtotal $ 4,346,154 1,016,667 $ 4.27

convertible preferred shares 153,846** —
Convertible bonds 18,000*** 100,000*** $ 0.18

convertible preferred shares (141,859)† —
Diluted EPS for common stock $ 4,376,141 1,116,667 $ 3.92

** <0.4 × 100,000 preferred shares ÷ {(0.4 × 100,000 preferred shares) + [0.6 × (1,000,000 common shares + 16,667
incremental shares from warrants)]}> × $2,500,000 undistributed earnings = $153,846.
*** Assumed conversion of the convertible bonds would result in 100,000 incremental common shares and
† <0.4 × 100,000 preferred shares ÷ {(0.4 × 100,000 preferred shares) + [0.6 × (1,000,000 common shares + 16,667
incremental shares from warrants + 100,000 incremental shares from the convertible bonds)]}> × ($2,500,000
undistributed earnings + $18,000 interest add-back) = $141,859.
Step 3 — Determine which Step — 2a or 2b — results in the more dilutive effect.

In this example, B would disclose an amount of diluted EPS per common share that would result from applying
the if-converted methods ($3.81) because that amount is more dilutive than the amount that would result from
applying the two-class method ($3.92). In accordance with ASC 260-10-45-60, B would be permitted, but not
required, to present basic and diluted EPS for the participating convertible preferred shares on the face of the
income statement.
471
Example 12-8
Use of the Two-Class Method to Calculate Basic and Diluted EPS — Participating Nonvested Share-
Based Payment Awards
Assume that Entity C has 1 million weighted-average shares of common stock outstanding for the fiscal year
On January 1, 20X1, C issues 250,000 nonvested share-based payment awards to its employees. The nonvested
shares have a grant-date fair-value-based measure of $50 per share and vest at the end of the fourth year of
service (i.e., cliff vesting). The average market price of A’s stock price for 20X1 was $60 per share.
Holders of nonvested shares have a nonforfeitable right to receive cash dividends on a 1:1 per-share basis with
the common shareholders. Accordingly, the nonvested shares are participating securities for which C must use
the two-class method in calculating basic and diluted EPS. In fiscal year 20X1, C declares and pays $2.5 million
in dividends for both the common shares and the nonvested shares.
Less: dividends paid
Shares of restricted stockholders 500,000
Common shareholders 2,000,000 2,500,000
To shares of restricted stock:
[250,000 shares of restricted stock* ÷ (250,000 shares of restricted stock* + 1,000,000

common shares**)] × $2,500,000 undistributed earnings*** = $500,000
$500,000 ÷ 250,000 shares of restricted stock* = $2.00 per share
To common shares:
[1,000,000 common shares** ÷ (250,000 shares of restricted stock* + 1,000,000 common

shares**] × $2,500,000 undistributed earnings*** = $2,000,000

* Weighted-average number of participating restricted shares outstanding.
Basic EPS amounts:
Participating
Shares of
Common Shares Restricted Stock
Total $ 4.00 $ 4.00
472

Because there are no potential common shares other than the participating nonvested shares, antidilution
sequencing is not required.
Calculation of diluted EPS for the common shares in which the use of the treasury stock method for the
participating nonvested shares is assumed:
As reported, basic $ 4,000,000* 1,000,000 $ 4.00
Participating shares of
restricted stock 1,000,000** 67,708*** —
Diluted EPS $ 5,000,000 1,067,708 $ 4.68

* Amount represents the aggregate of the distributed earnings ($2,000,000) and undistributed earnings ($2,000,000)
allocated to the common shareholders.
** Amount represents the aggregate of the distributed earnings ($500,000) and undistributed earnings ($500,000)
allocated to the participating shares of restricted stock.
*** Incremental number of shares for assumed vesting of shares of restricted stock under the treasury stock method:
• Exercise price = $0.
• Average unrecognized compensation cost = $10,937,500.

o $12,500,000 – [(250,000 shares × $50) ÷ 4 years] = $9,375,000.

o ($12,500,000 + $9,375,000) ÷ 2 = $10,937,500.
• Assumed proceeds of $10,937,500 = $0 from exercise + $10,937,500 average unrecognized compensation cost.
• Shares repurchased = 182,292 = $10,937,500 assumed proceeds ÷ $60 average share price.
• Incremental shares = 67,708 = 250,000 shares – 182,292 shares repurchased.

Because C’s capital structure only includes common shares and the participating shares of restricted stock (i.e.,
there are no other potential common shares), basic and diluted EPS would be the same under the two-class
method ($4.00).

In this example, C would disclose an amount of diluted EPS per common share that would result from applying
the two-class method ($4.00) because that amount is more dilutive than the amount that would result from
applying the treasury stock method ($4.68). In accordance with ASC 260-10-45-60, C would be permitted, but
not required, to present basic and diluted EPS for the participating shares of restricted stock on the face of the
income statement.
473
Example 12-9
Use of the Two-Class Method to Calculate Basic and Diluted EPS — Participating Nonvested Share-
Based Payment Awards With Convertible Debt and Warrants
Assume that Entity D has 1 million weighted-average shares of common stock outstanding for the fiscal year
On January 1, 20X1, D issues 250,000 nonvested share-based payment awards to its employees. The nonvested
shares have a grant-date fair-value-based measure of $50 per share and vest at the end of the fourth year
of service (i.e., cliff vesting). The average market price of D’s stock price for 20X1 is $60 per share. Holders
of nonvested shares have a nonforfeitable right to receive cash dividends on a 1:1 per-share basis with the
common shareholders. Accordingly, the nonvested shares are participating securities for which D must use the
two-class method in calculating basic and diluted EPS. In fiscal year 20X1, D declares and pays $2.5 million in
dividends for both the common shares and the nonvested shares.
In addition, assume the following:
• On January 1, 20X1, D issues warrants to purchase 100,000 shares of its common stock at $40 per share
for a period of five years. The warrants do not meet the definition of a participating security.
• On January 1, 20X1, D issues 10,000 units of convertible bonds with an aggregate par value of $1 million.
Each bond is convertible into 10 shares of D’s common stock and bears an interest rate of 3 percent.

Less: dividends paid
Shares of restricted stockholders 500,000
Common shareholders 2,000,000 2,500,000
To shares of restricted stock:

[250,000 shares of restricted stock* ÷ (250,000 shares of restricted stock* + 1,000,000 common
shares**)] × $2,500,000 undistributed earnings*** = $500,000
$500,000 ÷ 250,000 shares of restricted stock* = $2.00 per share
To common shares:
[1,000,000 common shares** ÷ (250,000 shares of restricted stock* + 1,000,000 common shares**)] ×
$2,500,000 undistributed earnings*** = $2,000,000
* Weighted-average number of participating restricted shares outstanding.

474
Basic EPS amounts:
Participating
Common Shares of
Shares Restricted Stock
Total $ 4.00 $ 4.00
Note that this calculation is the same as the calculation of basic EPS in Example 12-8 because basic EPS is not
affected by the warrants and convertible debt since neither security is a participating security.

Increase in
Earnings Available Increase in Earnings per
to Common Number of Incremental
Shareholders Common Shares Share
Warrants $ — 33,333* $ —
Convertible bonds 18,000** 100,000** 0.18
Participating shares of restricted stock $ 1,000,000*** 67,708† $ 14.77

† Incremental number of shares for assumed vesting of shares of restricted stock under the treasury stock method:
o $12,500,000 – [(250,000 shares × $50) ÷ 4 years] = $9,375,000.
o ($12,500,000 + $9,375,000) ÷ 2 = $10,937,500.
• Assumed proceeds of $10,937,500 = $0 from exercise + $10,937,500 average unrecognized compensation
cost.
475
Calculation of diluted EPS for the common shares in which the use of the treasury stock method for the
participating nonvested shares is assumed:
Warrants — 33,333*
$ 4,000,000 1,033,333 $ 3.87
Convertible bonds 18,000** 100,000**
$ 4,018,000 1,133,333 $ 3.55
Participating shares of restricted stock 1,000,000*** 67,708†
Diluted EPS $ 5,018,000 1,201,041 $ 4.18

† Incremental number of shares for assumed vesting of shares of restricted stock under the treasury stock method:

o $12,500,000 – [(250,000 shares × $50) ÷ 4 years] = $9,375,000.

o ($12,500,000 + $9,375,000) ÷ 2 = $10,937,500.
• Assumed proceeds of $10,937,500 = $0 from exercise + $10,937,500 average unrecognized compensation
cost.
476

allocated to the participating shares
of restricted stock 500,000 — —
Warrants — 33,333*

shares of restricted stock (487,013)** —
Subtotal $ 4,012,987 1,033,333 $ 3.88

shares of restricted stock 487,013** —
Convertible bonds 18,000*** 100,000*** $ 0.18

shares of restricted stock (455,060)† —
Diluted EPS for common stock $ 4,062,940 1,133,333 $ 3.58

** [250,000 shares of restricted stock ÷ (250,000 shares of restricted stock + 1,000,000 common shares + 33,333
incremental shares from warrants)] × $2,500,000 undistributed earnings = $487,013.
*** Assumed conversion of the convertible bonds would result in 100,000 incremental common shares and
† [250,000 shares of restricted stock ÷ (250,000 shares of restricted stock + 1,000,000 common shares + 33,333
incremental shares from warrants + 100,000 incremental shares from the convertible bonds)] × ($2,500,000
undistributed earnings + $18,000 interest add-back) = $455,060.

In this example, D would use the two-class method to disclose diluted EPS per common share ($3.58) because
that amount is more dilutive than the amount that would result from applying the if-converted method ($4.18).
In accordance with ASC 260-10-45-60, D would be permitted, but not required, to present basic and diluted
EPS for the participating shares of restricted stock on the face of the income statement.
477
12.4.4 Settlement in Shares or Cash

ASC 260-10

45-30 If share-based payment arrangements are payable in common stock or in cash at the election of either
the entity or the grantee, the determination of whether such share-based awards are potential common shares
shall be made based on the provisions in paragraph 260-10-45-45. If an entity has a tandem award (as defined
in Topic 718) that allows the entity or the grantee to make an election involving two or more types of equity
instruments, diluted EPS for the period shall be computed based on the terms used in the computation of
compensation cost for that period.
Contracts That May Be Settled in Stock or Cash

45-45 If an entity issues a contract that may be settled in common stock or in cash at the election of either
the entity or the holder, the determination of whether that contract shall be reflected in the computation of
diluted EPS shall be made based on the facts available each period. It shall be presumed that the contract will
be settled in common stock and the resulting potential common shares included in diluted EPS (in accordance
with the relevant provisions of this Topic) if the effect is more dilutive. Share-based payment arrangements that
are payable in common stock or in cash at the election of either the entity or the grantee shall be accounted for
pursuant to this paragraph and paragraph 260-10-45-46. An example of such a contract is a written put option
that gives the holder a choice of settling in common stock or in cash.
45-45 The effect of potential share settlement shall be included in the diluted EPS calculation (if the effect
is more dilutive) for an otherwise cash-settleable instrument that contains a provision that requires or
permits share settlement (regardless of whether the election is at the option of an entity or the holder,
or the entity has a history or policy of cash settlement). An example of such a contract accounted for in
accordance with this paragraph and paragraph 260-10-45-46 is a written call option that gives the holder
a choice of settling in common stock or in cash. An election to share settle an instrument, for purposes
of applying the guidance in this paragraph, does not include circumstances in which share settlement
is contingent upon the occurrence of a specified event or circumstance (such as contingently issuable
shares). In those circumstances (other than if the contingency is an entity’s own share price), the guidance
on contingently issuable shares should first be applied, and, if the contingency would be considered
met, then the guidance in this paragraph should be applied. Share-based payment arrangements
that are payable in common stock or in cash at the election of either the entity or the grantee shall be
accounted for pursuant to this paragraph and paragraph 260-10-45-46, unless the share-based payment
arrangement is classified as a liability because of the requirements in paragraph 718-10-25-15 (see
paragraph 260-10-45-45A for guidance for those instruments). If the payment of cash is required only
upon the final liquidation of an entity, then the entity shall include the effect of potential share settlement
in the diluted EPS calculation until the liquidation occurs.
45-45A For a share-based payment arrangement that is classified as a liability because of the
requirements in paragraph 718-10-25-15 and may be settled in common stock or in cash at the election of
either the entity or the holder, determining whether that contract shall be reflected in the computation of
diluted EPS shall be prepared on the basis of the facts available each period. It shall be presumed that the
contract will be settled in common stock and the resulting potential common shares included in diluted
EPS (in accordance with the relevant guidance of this Topic) if the effect is more dilutive. The presumption
that the contract will be settled in common stock may be overcome if past experience or a stated policy
provides a reasonable basis to conclude that the contract will be paid partially or wholly in cash.
478
45-46 A contract that is reported as an asset or liability for accounting purposes may require an adjustment
to the numerator for any changes in income or loss that would result if the contract had been reported as an
equity instrument for accounting purposes during the period. That adjustment is similar to the adjustments
required for convertible debt in paragraph 260-10-45-40(b). The presumption that the contract will be settled
in common stock may be overcome if past experience or a stated policy provides a reasonable basis to believe
that the contract will be paid partially or wholly in cash.
45-46 A contract that is reported as an asset or liability for accounting purposes may require an
adjustment to the numerator for any changes in income or loss that would result if the contract had been
reported as an equity instrument for accounting purposes during the period. That adjustment is similar to
the adjustments required for convertible debt in paragraph 260-10-45-40(b).
45-47 Paragraphs 260-10-55-32 through 55-36A provide additional guidance on contracts that may be settled
in stock or cash.
Contracts That May Be Settled in Stock or Cash

55-32 Adjustments shall be made to the numerator for contracts that are classified, in accordance with Section
815-40-25, as equity instruments but for which the entity has a stated policy or for which past experience
provides a reasonable basis to believe that such contracts will be paid partially or wholly in cash (in which case
there will be no potential common shares included in the denominator). That is, a contract that is reported as
an equity instrument for accounting purposes may require an adjustment to the numerator for any changes
in income or loss that would result if the contract had been reported as an asset or liability for accounting
purposes during the period. For purposes of computing diluted EPS, the adjustments to the numerator are
only permitted for instruments for which the effect on net income (the numerator) is different depending on
whether the instrument is accounted for as an equity instrument or as an asset or liability (for example, those
that are within the scope of Subtopics 480-10 and 815-40).
55-32 Adjustments shall be made to the numerator for contracts that are asset or liability classified,
in accordance with Section 815-40-25, but for which the potential common shares are included in the
denominator in accordance with the guidance in paragraph 260-10-45-45. For purposes of computing
diluted EPS, the adjustments to the numerator are only permitted for instruments for which the effect
on net income (the numerator) is different depending on whether the instrument is accounted for as an
equity instrument or as an asset or liability (for example, those that are within the scope of Subtopics
480-10 and 815-40).
55-33 The references in paragraphs 260-10-45-30 and 260-10-45-45 for share-based payment arrangements
that are payable in common stock or in cash at the election of either the entity or the grantee refer to using the
guidance in paragraph 260-10-45-45 for purposes of determining whether shares issuable in accordance with
such plans are included in the denominator for purposes of computing diluted EPS amounts. Accordingly, the
numerator is not adjusted in those circumstances. Paragraph 260-10-55-36A illustrates these requirements.
55-33 The references in paragraphs 260-10-45-30 and 260-10-45-45 for share-based payment
arrangements that are payable in common stock or in cash at the election of either the entity or the
grantee refer to using the guidance in paragraph 260-10-45-45A for purposes of determining whether
shares issuable in accordance with such plans are included in the denominator for purposes of computing
diluted EPS amounts. Accordingly, the numerator is not adjusted in those circumstances. Paragraph
260-10-55-36A illustrates these requirements.
479
55-34 Year-to-date diluted EPS calculations may require an adjustment to the numerator in certain
circumstances. For example, for contracts in which the counterparty controls the method of settlement and
that would have a more dilutive effect if settled in shares, the numerator adjustment is equal to the earnings
effect of the change in the fair value of the asset or liability recorded pursuant to Section 815-40-35 during the
year-to-date period. In that example, the number of incremental shares included in the denominator should be
determined by calculating the number of shares that would be required to settle the contract using the average
share price during the year-to-date period.
55-34 Year-to-date diluted EPS calculations may require an adjustment to the numerator in certain
circumstances. For example, for contracts that are share settled for EPS purposes, the numerator
adjustment is equal to the earnings effect of the change in the fair value of the asset or liability recorded
pursuant to Section 815-40-35 during the year-to-date period. In that example, the number of incremental
shares included in the denominator should be determined in accordance with the guidance in paragraph
260-10-55-3.
55-36 For contracts in which the counterparty controls the means of settlement, past experience or a stated
policy is not determinative. Accordingly, in those situations, the more dilutive of cash or share settlement shall
be used.
55-36A The following table illustrates the guidance in paragraphs 260-10-55-32 through 55-36 for the effects of
contracts that may be settled in stock or cash on the computation of diluted EPS.
Accounting for Adjustment Required to Adjustment Required

Assumed Book Purposes Book Earnings (Numerator) to Number of
Settlement for (per Topic 480 for Purposes of Computing Shares Included in
EPS Purposes(a) or 815) Diluted Earnings per Share?(b) Denominator?(b)
Shares Asset/Liability Yes (per paragraph 260-10-45-45) Yes
Shares Equity No Yes
Cash Asset/Liability No No
Cash Equity Yes (per Topic 260) No

(a) Note that for purposes of computing EPS, delivery of the full stated amount of cash in exchange for delivery of
the full stated number of shares (physical settlement) should be considered share settlement.
(b) Except for forward purchase contracts that require physical settlement by repurchase of a fixed number of
shares in exchange for cash. Topic 480 provides EPS guidance for those contracts.
480
55-36A The following table illustrates the guidance in paragraphs 260-10-45-45 through 45-46 and
260-10-55-32 through 55-34 for the effects of contracts that may be settled in stock or cash on the
computation of diluted EPS.
Accounting for Adjustment Required to Adjustment Required

Assumed Book Purposes Book Earnings (Numerator) to Number of
Settlement for (per Topic 480 for Purposes of Computing Shares Included in
EPS Purposes(a) or 815) Diluted Earnings per Share?(b) Denominator?(b)
Shares Asset/Liability Yes (per paragraph 260-10-45-45) Yes
Shares Equity No Yes
Cash Asset/Liability No No
(a) Note that for purposes of computing EPS, delivery of the full stated amount of cash in exchange for delivery of
the full stated number of shares (physical settlement) should be considered share settlement.
(b) Except for forward purchase contracts that require physical settlement by repurchase of a fixed number of
shares in exchange for cash. Topic 480 provides EPS guidance for those contracts.
Share-based payment awards that are based on the price of an entity’s shares (e.g., cash-settled SARs)
but cannot be settled in the entity’s shares (i.e., they must be settled in cash and are therefore classified
as share-based liabilities) are not included in the denominator of basic or diluted EPS. That is, share-
based payment awards that always must be settled in cash are not included in the denominator in
the EPS computation. However, the compensation cost recorded in net income (and therefore income
available to common shareholders) will affect the numerator in the EPS computation.
Conversely, a share-based payment award that can be settled in cash or shares is evaluated under
ASC 260-10-45-45 through 45-47. If the award may be settled at the election of the entity, the award’s
classification must be based on the facts available in each period. Since it is presumed that a share-
based payment award will be settled in shares, the entity must include the incremental number of
shares that results from applying the treasury stock method in the denominator of the calculation
of diluted EPS if the effect is dilutive on the basis of the antidilution sequencing requirements of ASC
260. There are two exceptions to the requirement to include the incremental number of shares in the
denominator of the calculation of diluted EPS:
• Before the adoption of ASU 2020-06, the presumption of share settlement may be overcome
if it is reasonable to conclude, on the basis of an entity’s past experience or stated policy, that
the award will be settled in cash. If an entity is able to overcome the presumption of share
settlement, the substantive terms of the award might suggest that the entity will cash settle the
award. In such a case, the entity will also be required to classify the award as a share-based
liability in accordance with ASC 718-10-25-15.
• After the adoption of ASU 2020-06, the presumption of share settlement may be overcome for
a share-based payment award that is classified as a liability because of the requirements in ASC
718-10-25-15 if past experience or a stated policy provides a reasonable basis for an entity to
conclude that the arrangement will be settled in cash. See ASC 260-10-45-45A (added by ASU
2020-06) for further details.
481
When an award is classified as a liability and share settlement is presumed, the entity should adjust
the numerator of the calculation of diluted EPS to remove the incremental effect of accounting for the
award as a liability (i.e., adjust the numerator so that it reflects only the compensation cost that would
have been recognized if the award had been classified as equity). In addition, in computing the average
unrecognized cost of the arrangement for application of the treasury stock method in the denominator
of the calculation of diluted EPS, the entity should use the amount of cost that would have been left
unrecognized if the award had been classified as equity.
Changing Lanes
ASU 2020-06 eliminates the ability to overcome the presumption of share settlement
for contracts other than share-based payment arrangements. For share-based payment
arrangements, the FASB decided to retain the existing guidance. Paragraph BC114 of ASU
2020-06 states:
The classification guidance in Topic 718 is different from the classification guidance in Subtopic
815-40. Specifically, the guidance in paragraph 718-10-25-15 states that “. . . 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.” Under current GAAP, a liability-classified stock-based
compensation arrangement may not be included in diluted EPS because of the existing guidance on
contracts that may be settled in cash or shares. The Board decided to retain the current guidance for
calculating diluted EPS for stock-based compensation because those arrangements are not within the
scope of this project.
12.4.5 Early Exercise of Stock Options

An early exercise refers to a grantee’s ability to change his or her tax position by exercising an option
or similar instrument and receiving shares before the good has been delivered or the service has been
rendered (i.e., before the award vests). If the employee terminates employment before rendering the
requisite service (or a nonemployee forfeits the award before completion of the vesting period), the
entity usually can repurchase the shares for either of the following:
award.

The purpose of the repurchase feature is effectively to require the grantee to satisfy the vesting
conditions to receive any economic benefit from the award. Early exercise is therefore not considered to
be a substantive exercise for accounting purposes. See Section 3.4.3 for additional information.
12.4.5.1 Basic EPS
The shares issued to a grantee upon an award’s early exercise would not be considered outstanding for
basic EPS purposes until the award’s vesting conditions have been satisfied. This conclusion is consistent
with the intent of ASC 260-10-45-13, which is that shares that are subject to a contingent repurchase
provision, as described above, are excluded from the computation of basic EPS until the shares are no
longer contingently returnable (i.e., the entity’s call option lapses).
However, if the shares subject to repurchase contain nonforfeitable rights to dividends or dividend
equivalents, the shares are participating securities. That is, an award is considered a participating
security if it accrues cash dividends (whether paid or unpaid) any time the common shareholders receive
dividends that do not need to be returned to the entity if the grantee forfeits the award. If legally issued
shares are considered participating securities, the entity must use the two-class method to compute
basic EPS. See Section 12.4.3 for a discussion of the two-class method.
482
12.4.5.2 Diluted EPS
After a grantee early exercises an option, the entity continues to use the treasury stock method to
compute diluted EPS. When using this method to calculate the number of incremental shares to be
included in diluted EPS, the entity normally is required to include the exercise price of the award in the
computation of assumed proceeds in accordance with ASC 260-10-45-29. (See Section 12.4.2.1 for a
discussion of the application of the treasury stock method to share-based payment awards.) However,
in this case, because the grantee has early exercised the award and has therefore already paid cash,
(1) there is no cash that will be received from the grantee in the future and (2) the cash received
hypothetically could have already been used to repurchase shares during the requisite service period
(or before the nonemployee award has vested). As a result, the cash received is not included in the
computation of assumed proceeds.
When computing diluted EPS for an early exercised award that is considered a participating security, an
entity must determine whether the treasury stock method or the two-class method is more dilutive.
12.4.6 Employee Stock Purchase Plans

12.4.6.1 General
An ESPP is a share-based payment plan that is usually offered to a broad base of employees so that
they can participate in ownership of the entity, generally at a discounted price. Employees contribute
to the plan through payroll deductions during the purchase period (e.g., six months). At the end of
the purchase period, the employer’s stock is purchased at the purchase price, which is generally a
discounted price. See Chapter 8 for a discussion of ESPPs.
The effect that an ESPP has on an entity’s EPS depends on the terms of the plan. Generally, the
participating employees can choose not to purchase the shares and can have their withholdings during
the purchase period refunded because either (1) the employees can elect to have previous withholdings
refunded before the end of the purchase period or (2) the shares will not be purchased if the employee
fails to provide the requisite service (i.e., if the employee terminates employment before the end of the
purchase period). In practice, it is atypical for an employee’s withholdings during the purchase period
not to be refundable because participants are generally not allowed to purchase shares at the end of
the purchase period if they are no longer employed by the entity. However, the section below addresses
the EPS accounting for ESPPs for which the participating employees are unable to receive a refund of
withholdings made during the purchase period.
12.4.6.2 Withholdings Are Not Refundable

If the terms of the ESPP do not allow employees to choose not to purchase the shares (i.e., an
employee’s participation is irrevocable because the employee is not entitled to a refund of amounts
previously withheld during the purchase period, regardless of whether the employee is terminated), the
guidance on contingently issuable shares applies to the calculation of basic and diluted EPS. According
to this guidance, the number of shares, if any, that would be issuable at the end of the reporting period,
under the assumption that the end of the reporting period is the end of the purchase period (this
number is based on the amounts withheld by the entity to date), is included in the weighted-average
number of common shares outstanding for basic and diluted EPS.
483
12.4.6.3 Withholdings Are Refundable

12.4.6.3.1 Basic EPS
If the terms of the ESPP allow employees to choose not to purchase the shares (i.e., employees are
entitled to a refund of amounts previously withheld during the purchase period either at their election
or upon termination of employment), the shares issuable under the ESPP are treated as employee stock
options that are granted as of the beginning of the purchase period. Accordingly, the shares issuable
under the ESPP are not included in the denominator of the calculation of basic EPS until they have
been actually issued. This stipulation is consistent with the EPS accounting for employee stock options
as discussed in Section 12.4.5.1. The fact that the shares issuable under the ESPP are not included in
basic EPS during the purchase period is based on the guidance in ASC 260-10-45-12C on contingently
issuable shares.
12.4.6.3.2 Diluted EPS
As discussed in the previous section, when the terms of the ESPP allow employees to choose not to
purchase the shares, the shares issuable under the ESPP are treated as employee stock options that
are granted as of the beginning of the purchase period. Accordingly, the shares issuable under the ESPP
are included in the denominator of diluted EPS under the treasury stock method, as discussed in ASC
260-10-45-22 through 45-29A. To apply the treasury stock method to an ESPP, an entity must also apply
the guidance on contingently issuable shares, as discussed in ASC 260-10-45-48 and 45-49 and ASC
260-10-45-52.
Because the participants’ ability to purchase shares under an ESPP is based on a service condition,
the grant date and service inception date are the start date of the purchase period provided that
all conditions for establishing a grant date have been met. The withholding of amounts from the
employees’ pay during the purchase period merely represents the funding mechanism for the eventual
payment of the exercise price. This withholding mechanism does not affect the grant date or service
inception date of the ESPP.
The number of incremental common shares to be included in the calculation of diluted EPS is based
on the number of shares that would be issuable if the reporting date were the end of the contingency
period (i.e., the purchase period) in accordance with ASC 260-10-45-52, net of the hypothetical shares
that could be repurchased in accordance with the treasury stock method. Therefore, the sponsor of an
ESPP must consider each of the following to calculate the effect of the ESPP on diluted EPS:
• Employee withholdings — The amount of employee withholdings represents the exercise price
for the shares to be purchased by employees and is also used to calculate the number of shares
assumed to be issued during the purchase period. For diluted EPS purposes, this amount
should represent the total amount of employee withholdings expected to be made during the
entire purchase period.3 To estimate this amount, entities should consider the elections made
by participating employees.
Expected forfeitures may affect the amount of recognized compensation cost during the
purchase period but should not be factored into the estimation of employee withholdings.
As discussed in Section 12.4.2.1.4, regardless of an entity’s accounting policy election related
to how it reflects forfeitures in the recognition of compensation cost, the denominator in the
calculation of diluted EPS is based on the actual number of awards outstanding (i.e., the number
3
The entire purchase period is considered in the calculation of diluted EPS because the shares to be purchased under the ESPP are treated as
employee stock options. Therefore, all amounts to be withheld from employees’ pay to purchase shares under the ESPP (i.e., withholdings to date
and expected future withholdings during the remaining purchase period) must be considered in the calculation of diluted EPS.
484
of awards is reduced only for actual forfeitures) in a given reporting period provided that the
effect is dilutive.
Changes to employee withholding elections during the purchase period are treated as
modifications and are only reflected in EPS prospectively.
• Purchase price formula — The purchase price of an ESPP is generally based on the lesser of
the stock price at the beginning of the purchase period and that at the end of the purchase
period; therefore, the sponsor will need to consider its stock price as of both the beginning of
the purchase period and the end of the reporting period. The stock price as of the end of the
reporting period is used as the proxy for the stock price as of the end of the purchase period
in accordance with the guidance in ASC 260-10-45-52 on contingently issuable shares. The
sponsor would use the lower of these two stock prices to calculate the purchase price when
the ESPP allows employees to purchase shares on the basis of a formula that incorporates the
lesser of the stock price at the beginning and that at the end of the purchase period.
• Average unrecognized compensation cost — The average amount of unrecognized compensation

cost attributable to future service, if any, is a component of the assumed proceeds under the
treasury stock method.
The incremental number of common shares included in diluted EPS is calculated as follows (see also
Example 12-10):
Number of shares assumed issued under the ESPP:
Employee withholdings (item 1 above) ÷ purchase price (item 2 above)
less
Number of shares assumed repurchased:
Assumed proceeds (i.e., employee withholdings [item 1 above] plus average unrecognized
compensation cost [item 3 above]) ÷ average market price of the issuer’s stock for the
reporting period
Connecting the Dots

Unlike an entity’s accounting for diluted EPS for early exercised stock options, an entity may
include the money withheld (and expected to be withheld during the remaining purchase
period) from employees’ pay as a component of the assumed proceeds in calculating diluted
EPS for ESPPs. These withholdings are not considered a prepayment of the exercise price for
diluted EPS purposes because the entity must refund such amounts to employees that do not
ultimately purchase shares under the ESPP. (This requirement differs from the terms of early
exercised stock options.)
485
Example 12-10
Diluted EPS for ESPP

On July 1, 20X1, Entity A establishes a qualified ESPP that allows its employees to purchase shares of its common
stock during a six-month purchase period that begins on July 1, 20X1, and ends on December 31, 20X1. The
ESPP permits A’s employees to elect to withhold up to 10 percent of their salary to purchase A’s common stock
at the end of the purchase period. Employees may make their election at any time during the purchase period,
but once the election is made it cannot be changed during the purchase period. The shares will be purchased at
a price per share that is equal to the lesser of (1) 90 percent of A’s stock price as of July 1, 20X1, or (2) 90 percent
of A’s stock price as of December 31, 20X1. Participants are allowed to withdraw from the ESPP at any time
before the end of the purchase period and are automatically withdrawn if they are terminated before the end of
the purchase period. For any such withdrawals, A must refund the amounts withheld from the participant’s pay.
Shares are issued under the ESPP on January 1, 20X2.
Assumptions related to A’s calculation of diluted EPS for the quarterly period ended September 30, 20X1,
include the following:
• Common stock prices per share:

o July 1, 20X1 — $50.
o September 30, 20X1 — $40.
o Average market price during the period beginning on July 1, 20X1, and ending on September 30,
20X1 — $45.
• Employee payroll withholdings:
o Actual through September 30, 20X1 — $3.5 million.
o Expected from October 1, 20X1, through December 31, 20X1 — $3.7 million.
• Average unrecognized compensation cost for the period — $1.3 million.
The effect on diluted EPS of the ESPP for the quarterly period ended September 30, 20X1, is calculated as
follows:
Shares assumed issued under the ESPP 200,000*

Assumed proceeds:
Total expected withholdings $ 7,200,000
Average unrecognized compensation cost 1,300,000
Total $ 8,500,000
Average share price during the period $ 45
Shares assumed repurchased (188,889)**

Incremental common shares to include in diluted EPS 11,111
* Total payroll withholdings divided by 90 percent of the stock price as of September 30, 20X1
([$3,500,000 + $3,700,000] ÷ [90% × $40]) = 200,000.
** Total assumed proceeds divided by average market price during the period ($8,500,000 ÷ 45) =
188.889.
The shares issuable under the ESPP would be included in basic EPS prospectively once they are issued (i.e., on
January 1, 20X2). While not relevant to this example, if the purchase period ended during a quarterly financial
reporting period, in addition to including the shares as outstanding on a weighted-average basis for the period,
an entity would need to include incremental shares in diluted EPS on a weighted-average basis for the portion
of the quarterly period for which the shares had not yet been issued. See Section 4.2.2.1.3.1 of Deloitte’s
Roadmap Earnings per Share for further discussion.
486
Changing Lanes
ASC 260-10-45-21A (added by ASU 2020-06) states:
Changes in an entity’s share price may affect the exercise price of a financial instrument or the
number of shares that would be used to settle the financial instrument. For example, when the
principal of a convertible debt instrument is required to be settled in cash but the conversion
premium is required to (or may) be settled in shares, the number of shares to be included in the
diluted EPS denominator is affected by the entity’s share price. In applying both the treasury stock
method and the if-converted method of calculating diluted EPS, the average market price shall
be used for purposes of calculating the denominator for diluted EPS when the number of shares
that may be issued is variable, except for contingently issuable shares within the scope of the
guidance in paragraphs 260-10-45-48 through 45-57. See paragraphs 260-10-55-4 through 55-5 for
implementation guidance on determining an average market price.
If, after adopting ASU 2020-06, an entity applies ASC 260-10-45-21A to determine the number of
shares assumed to be issued under an ESPP, it would use the average market price of its stock
to calculate this number. However, before adopting ASU 2020-06, entities applied the guidance
on contingently issuable shares in ASC 260-10-45-52 to calculate the number of shares assumed
to be issued under an ESPP (as noted in the guidance and example above). This guidance is
consistent with footnote 1 of FASB Technical Bulletin 97-1 (superseded), which indicated that
an entity applies the guidance on contingently issuable shares to determine the accounting for
diluted EPS.
On the basis of informal discussions with the FASB staff, we understand that the amendments
made to ASC 260 by ASU 2020-06 (i.e., the addition of ASC 260-10-45-21A) were not intended
to address when the guidance on contingently issuable shares applies to the calculation of
diluted EPS. Indeed, ASC 260-10-45-21A specifically states that these amendments do not apply
to contingently issuable shares. Therefore, we believe that the accounting for diluted EPS that
entities applied in practice before adopting ASU 2020-06 is still acceptable after they adopt
this ASU. However, because it is often difficult to determine when to apply the guidance on
contingently issuable shares in ASC 260, it would also be acceptable for an entity to apply the
guidance in ASC 260-10-45-21A on variable denominators to calculate the number of shares
assumed to be issued under an ESPP after the adoption of ASU 2020-06. Such accounting for
diluted EPS would represent an accounting policy election that must be applied consistently.
If ASC 260-10-45-21A is applied to calculate the number of shares assumed to be issued in

Example 12-10, the number of shares would equal 177,778 (i.e., total expected withholdings
of $7,200,000 divided by $40.50 [$45 average market price for the period multiplied by 90
percent]). As a result, the ESPP would be antidilutive for the period since the number of shares
assumed to be repurchased would be greater than the number of shares assumed to be
issued. This example illustrates that an entity’s application of ASC 260-10-45-21A to calculate the
number of shares assumed to be issued in an ESPP would result in less dilution (or no dilution)
compared with application of the contingently issuable share method.
487
12.4.7 Redeemable Awards
ASC 260-10
Certain Redeemable Financial Instruments

45-70A Paragraph 480-10-45-4 provides guidance on calculating basic and diluted EPS if an entity has
mandatorily redeemable shares of common stock or has entered into certain forward contracts that require
physical settlement by repurchase of a fixed number of the issuer’s equity shares of common stock.
ASC 480-10
EPS
45-4 Entities that have issued mandatorily redeemable shares of common stock or entered into forward
contracts that require physical settlement by repurchase of a fixed number of the issuer’s equity shares of
common stock in exchange for cash shall exclude the common shares that are to be redeemed or repurchased
in calculating basic and diluted earnings per share (EPS). Any amounts, including contractual (accumulated)
dividends and participation rights in undistributed earnings, attributable to shares that are to be redeemed or
repurchased that have not been recognized as interest costs in accordance with paragraph 480-10-35-3 shall
be deducted in computing income available to common shareholders (the numerator of the EPS calculation),
consistently with the two-class method set forth in paragraphs 260-10-45-60 through 45-70.
SEC Staff Announcement: Classification and Measurement of Redeemable Securities

S99-3A(21) Common stock instruments issued by a parent (or single reporting entity). Regardless of the accounting
method selected in paragraph 15, the resulting increases or decreases in the carrying amount of redeemable
common stock should be treated in the same manner as dividends on nonredeemable stock and should
be effected by charges against retained earnings or, in the absence of retained earnings, by charges against
paid-in capital. However, increases or decreases in the carrying amount of a redeemable common stock
should not affect income available to common stockholders. Rather, the SEC staff believes that to the extent
that a common shareholder has a contractual right to receive at share redemption (in other than a liquidation
event that meets the exception in paragraph 3(f)) an amount that is other than the fair value of the issuer’s
common shares, then that common shareholder has, in substance, received a distribution different from
other common shareholders. Under Paragraph 260-10-45-59A, entities with capital structures that include a
class of common stock with different dividend rates from those of another class of common stock but without
prior or senior rights, should apply the two-class method of calculating earnings per share. Therefore, when a
class of common stock is redeemable at other than fair value, increases or decreases in the carrying amount
of the redeemable instrument should be reflected in earnings per share using the two-class method.FN17 For
common stock redeemable at fair valueFN18, the SEC staff would not expect the use of the two-class method, as
a redemption at fair value does not amount to a distribution different from other common shareholders.FN19.
The two-class method of computing earnings per share is addressed in Section 260-10-45. The SEC staff believes
FN17
that there are two acceptable approaches for allocating earnings under the two-class method when a common stock
instrument is redeemable at other than fair value. The registrant may elect to: (a) treat the entire periodic adjustment
to the instrument’s carrying amount (from the application of paragraphs 14–16) as being akin to a dividend or (b) treat
only the portion of the periodic adjustment to the instrument’s carrying amount (from the application of paragraphs
14–16) that reflects a redemption in excess of fair value as being akin to a dividend. Under either approach, decreases in
the instrument’s carrying amount should be reflected in the application of the two-class method only to the extent they
represent recoveries of amounts previously reflected in the application of the two-class method.
Common stock that is redeemable based on a specified formula is considered to be redeemable at fair value if the
FN18
formula is designed to equal or reasonably approximate fair value. The SEC staff believes that a formula based solely
on a fixed multiple of earnings (or other similar measure) is not considered to be designed to equal or reasonably
approximate fair value.
Similarly, the two-class method is not required when share-based payment awards granted to employees are redeemable
FN19
at fair value (provided those awards are in the form of common shares or options on common shares). However, those
share-based payment awards may still be subject to the two-class method pursuant to Section 260-10-45.
488
SAB Topic 14.E requires public entities to consider the requirements of ASR 268 (FRR Section 211) and
ASC 480-10-S99-3A for redeemable share-based payment awards. See Section 5.10 for a discussion of
the recognition and measurement requirements for redeemable share-based payment awards.
12.4.7.1 Share-Based Payment Awards Redeemable at Fair Value

Share-based payment awards on common shares that are redeemable at fair value are accounted
for in the same manner as common shares that are redeemable at fair value. In ASC 480-10-S99-3A,
the SEC staff clarified that increases or decreases in the carrying amount of common shares that are
redeemable at fair value do not affect income available to common shareholders. That is, changes in
the redemption amount do not affect income available to common shareholders (the numerator in the
calculation of basic EPS) if the redemption value of redeemable shares is based on the fair value of the
shares.
When computing diluted EPS, an entity must apply the treasury stock method to determine the number
of incremental shares to include in the calculation’s denominator. See Section 12.4.2.1 for a discussion
of the application of the treasury stock method to share-based payment awards.
12.4.7.2 Share-Based Payment Awards Redeemable at an Amount Other Than

Fair Value
Share-based payment awards on common shares that are redeemable at an amount other than fair
value are accounted for in the same manner as common shares that are redeemable at an amount
other than fair value (e.g., formula price). That is, increases or decreases in the carrying amount
of redeemable share-based payment awards are reflected in EPS under the two-class method, as
discussed in ASC 260-10-45-59A through 45-70. The increase or decrease in the carrying amount
of redeemable share-based payment awards is treated similarly to the reduction in income from
continuing operations (or net income) from current-period distributions. See Section 12.4.3 for a
discussion of the application of the two-class method.
In computing diluted EPS, an entity must determine whether the treasury stock method or the two-class
method is more dilutive. See Section 12.4.2.1 for a discussion of the application of the treasury stock
method to share-based payment awards.
12.4.7.3 Share-Based Payment Awards Redeemable at Intrinsic Value

The SEC’s guidance in ASC 480-10-S99-3A does not address the EPS treatment of share-based payment
awards with a redemption amount that is based on an award’s intrinsic value. Entities may therefore
make a policy decision to (1) analogize to the guidance in ASC 480-10-S99-3A on common shares that
are redeemable at fair value or (2) treat the increases or decreases in the carrying amount of these
awards as an additive or subtractive amount in arriving at income available to common shareholders.
Under the first alternative, the increase or decrease in the carrying amount of the redeemable share-
based payment award (i.e., changes in the redemption amount) does not affect income available to
common shareholders (the numerator in the calculation of basic EPS). Under the second alternative,
however, such increase or decrease is treated like a preferential distribution. That is, the entity accounts
for the current-period change in the carrying amount of the redeemable share-based payment award
as an additive or subtractive amount in arriving at income available to common shareholders (the
numerator in the calculation of basic EPS).
489
Regardless of the alternative selected, the entity must apply the treasury stock method to determine
the number of incremental shares to include in the denominator of the calculation of diluted EPS. See
Section 12.4.2.1 for a discussion of the application of the treasury stock method to share-based payment
awards.
12.4.7.4 Contingently Redeemable Share-Based Payment Awards

Share-based payment awards on common shares that are contingently redeemable at fair value or at
an amount other than the awards’ fair value (e.g., redeemable upon a change in control) do not affect
income available to common shareholders (the numerator in the calculation of basic EPS) until it is
probable that the contingency will occur. That is, awards that are contingently redeemable are not
remeasured to their redemption amount until it is deemed probable that the contingency will occur.
When computing diluted EPS, an entity must apply the treasury stock method to determine the number
of incremental shares to include in the denominator of the calculation. See Section 12.4.2.1 for a
discussion of the application of the treasury stock method to share-based payment awards.
12.4.8 Awards of a Consolidated Subsidiary

12.4.8.1 Share-Based Payment Awards Issued by a Consolidated Subsidiary and
Settled in the Subsidiary’s Common Shares
ASC 260-10
Securities of Subsidiaries
55-20 The effect on consolidated EPS of options, warrants, and convertible securities issued by a subsidiary
depends on whether the securities issued by the subsidiary enable their holders to obtain common stock
of the subsidiary or common stock of the parent entity. The following general guidelines shall be used for
computing consolidated diluted EPS by entities with subsidiaries that have issued common stock or potential
common shares to parties other than the parent entity
a. Securities issued by a subsidiary that enable their holders to obtain the subsidiary’s common stock shall
be included in computing the subsidiary’s EPS data. Those per-share earnings of the subsidiary shall
then be included in the consolidated EPS computations based on the consolidated group’s holding of
the subsidiary’s securities. Example 7 (see paragraph 260-10-55-64) illustrates that provision.
b. Securities of a subsidiary that are convertible into its parent entity’s common stock shall be considered
among the potential common shares of the parent entity for the purpose of computing consolidated
diluted EPS. Likewise, a subsidiary’s options or warrants to purchase common stock of the parent entity
shall be considered among the potential common shares of the parent entity in computing consolidated
diluted EPS. Example 7 (see paragraph 260-10-55-64) illustrates that provision.
55-21 The preceding provisions also apply to investments in common stock of corporate joint ventures and
investee companies accounted for under the equity method.
55-22 The if-converted method shall be used in determining the EPS impact of securities issued by a parent
entity that are convertible into common stock of a subsidiary or an investee entity accounted for under the
equity method. That is, the securities shall be assumed to be converted and the numerator (income available to
common stockholders) adjusted as necessary in accordance with the provisions in paragraph 260-10-45-40(a)
through (b). In addition to those adjustments, the numerator shall be adjusted appropriately for any change in
the income recorded by the parent (such as dividend income or equity method income) due to the increase
in the number of common shares of the subsidiary or equity method investee outstanding as a result of the
assumed conversion. The denominator of the diluted EPS computation would not be affected because the
number of shares of parent entity common stock outstanding would not change upon assumed conversion.
490
Example 7: Securities of a Subsidiary — Computation of Basic and Diluted EPS

55-64 This Example illustrates the EPS computations for a subsidiary’s securities that enable their holders to
obtain the subsidiary’s common stock based on the provisions in paragraph 260-10-55-20. The facts assumed
are as follows:
55-65 Parent Entity:

a. Net income was $10,000 (excluding any earnings of or dividends paid by the subsidiary).
b. 10,000 shares of common stock were outstanding; the parent entity had not issued any other securities.
c. The parent entity owned 900 common shares of a domestic subsidiary entity.
d. The parent entity owned 40 warrants issued by the subsidiary.
e. The parent entity owned 100 shares of convertible preferred stock issued by the subsidiary.
55-66 Subsidiary Entity:

a. Net income was $3,600.
b. 1,000 shares of common stock were outstanding.
c. Warrants exercisable to purchase 200 shares of its common stock at $10 per share (assume $20
average market price for common stock) were outstanding.
d. 200 shares of convertible preferred stock were outstanding. Each share is convertible into two shares of
common stock.
e. The convertible preferred stock paid a dividend of $1.50 per share.
f. No interentity eliminations or adjustments were necessary except for dividends.
g. Income taxes have been ignored for simplicity.
491
55-67 The following table illustrates subsidiary’s EPS.
Subsidiary’s Earnings per Share
Basic EPS $3.30 Computed: ($3,600(a) – $300(b)) ÷ 1,000(c))
Diluted EPS $2.40 Computed: $3,600(d) ÷ (1,000 + 100(e) + 400(f))
Consolidated Earnings per Share
Basic EPS $1.31 Computed: ($10,000(g) + $3,120(h)) ÷ 10,000(i)
Diluted EPS $1.27 Computed: ($10,000 + $2,160(j) + $48(k) + $480(l)) ÷ 10,000
(a) Subsidiary’s net income

(b) Dividends paid by subsidiary on convertible preferred stock
(c) Shares of subsidiary’s common stock outstanding
(d) Subsidiary’s income available to common stockholders ($3,300) increased by $300 preferred dividends from
applying the if-converted method for convertible preferred stock
(e) Incremental shares from warrants from applying the treasury stock method, computed: [($20 – $10) ÷ $20] ×
200
(f) Shares of subsidiary’s common stock assumed outstanding from conversion of convertible preferred stock,
computed: 200 convertible preferred shares × conversion factor of 2
(g) Parent’s net income
(h) Portion of subsidiary’s income to be included in consolidated basic EPS, computed: (900 × $3.30) + (100 ×
$1.50)
(i) Shares of parent’s common stock outstanding
(j) Parent’s proportionate interest in subsidiary’s earnings attributable to common stock, computed: (900 ÷
1000) × (1000 shares × $2.40 per share)
(k) Parent’s proportionate interest in subsidiary’s earnings attributable to warrants, computed: (40 ÷ 200) × (100
incremental shares × $2.40 per share)
(l) Parent’s proportionate interest in subsidiary’s earnings attributable to convertible preferred stock, computed:
(100 ÷ 200) × (400 shares from conversion × $2.40 per share)
Share-based payment awards issued by a consolidated subsidiary that are settled by issuing the
subsidiary’s common shares affect not only the subsidiary’s computation of diluted EPS but also
the computation of the parent’s diluted EPS, as described in ASC 260-10-55-20 through 55-22 and
illustrated in Example 7 in ASC 260-10-55-64 through 55-67.
While such awards do not affect the weighted-average number of common shares outstanding (i.e., the
denominator in the calculation of basic EPS for either the subsidiary or the parent), the compensation
cost associated with these awards (during the requisite service period or nonemployee’s vesting period)
will generally affect both the subsidiary’s and the parent’s net income or loss.
492
To compute the parent’s diluted EPS, the subsidiary must first calculate its own diluted EPS (regardless
of whether the subsidiary reports EPS). The amount of the subsidiary’s diluted EPS is then multiplied by
the number of the subsidiary’s shares that the parent is assumed to own (after the hypothetical exercise
of the awards is taken into consideration). The product of those two amounts is then included in the
numerator (as a substitute for the parent’s proportionate share of the subsidiary’s earnings) of the
calculation of the parent’s diluted EPS.
As noted in ASC 260-10-55-21, the guidance in ASC 260-10-55-20 also applies to investments in common
stock of corporate joint ventures and investee companies that are accounted for under the equity method.
Example 12-11
Impact on EPS of Share-Based Payment Awards Issued by a Subsidiary

Assume that the following apply to Parent P:
• Its net income is $100, excluding any net income or loss of Subsidiary A (i.e., as if A is unconsolidated).
• Throughout the period, 100 shares of its common stock were outstanding. No other securities have
been issued.
• It owns 90 of A’s common shares (out of 100 outstanding).
Assume that the following apply to A:
• Its net income is $100 (after intercompany eliminations, etc.).

• Throughout the period, 100 shares of its common stock were outstanding.
• At the beginning of the period, it granted 10 fully vested stock options to its employees to purchase 10
shares of its common stock at $1 per share.
• The average market price of its common stock during the period is $2 per share.
The calculation of A’s diluted EPS is as follows:
Average number of shares of A’s common stock outstanding 100
Incremental number of shares from stock options from

applying the treasury stock method [(assumed proceeds
of $10)* ÷ (average market price of $2)] 5
Weighted-average number of shares – diluted 105
Subsidiary A’s net income $ 100
Diluted EPS – A ($100 net income ÷ 105 A shares) $ 0.95

* Assumed proceeds do not include average unrecognized compensation cost for
the period because the stock options are fully vested.
493
The calculation of P’s consolidated diluted EPS is as follows:
Parent P’s net income (unconsolidated) $ 100
Parent P’s proportionate interest in A’s earnings attributable

to common stock [100 A shares outstanding × $0.95
A’s diluted EPS × (90 A shares owned ÷ 100 A shares
outstanding)] 86
Parent P’s income available to common shareholders

(excluding income attributable to the NCI) $ 186
Weighted-average number of shares – diluted (100 P shares) 100
Consolidated diluted EPS ($185.50 of P’s income available to

common shareholders ÷ 100 P shares) $ 1.86
12.4.8.2 Share-Based Payment Awards Issued by a Subsidiary but Settled in the

Parent’s Common Shares
Share-based payment awards issued by a consolidated subsidiary that are settled by issuing the parent’s
common shares will not affect the subsidiary’s denominator in the calculation of diluted EPS because the
awards do not represent potential common shares of the subsidiary. However, during the employee’s
requisite service period or nonemployee’s vesting period, the compensation cost associated with these
awards will affect the subsidiary’s net income or loss. (See Sections 2.8 and 2.9 for a discussion of the
accounting for share-based payment awards issued by a subsidiary but settled in the parent’s common
shares.)
By contrast, for the parent, the share-based payment awards do represent potential common shares in
the computation of diluted EPS. Therefore, the awards are included in the parent’s denominator of the
calculation of diluted EPS under the treasury stock method. (See Section 12.4.2.1 for a discussion of
the application of the treasury stock method to share-based payment awards.) Because the subsidiary
is recording compensation cost in its financial statements for these awards during the requisite service
period or nonemployee’s vesting period, the parent’s proportionate share of the compensation cost will
have been included in the parent’s net income or loss.
494
Chapter 13 — Disclosure
13.1 Disclosure Objective
ASC 718 specifies the information entities must disclose about their share-based payment arrangements
in the notes to the financial statements. The disclosure objectives related to such arrangements are
outlined in ASC 718-10-50-1.
ASC 718-10
50-1 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 718-10-55-134 through 55-137) for an illustration of this guidance.
See Section 13.3 for examples of the disclosures required under ASC 718.
13.2 Minimum Disclosures
ASC 718-10-50-2 and 50-2A outline the “minimum information” an entity must disclose in its annual
financial statements to achieve the four objectives specified in ASC 718-10-50-1.
495
ASC 718-10
50-2 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. The number and weighted-average grant-date fair value (or calculated value for a nonpublic entity
that uses that method or intrinsic value for awards measured pursuant to paragraph 718-10-30-21)
of equity instruments not specified in (c)(1), for all of the following groups of equity instruments:
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 718-10-30-21
through 30-22) 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).
496
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 718-10-30-21 through 30-22 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.
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. A description of significant modifications, including:
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.
497
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. Subparagraph superseded by Accounting Standards Update No. 2016-09
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.
50-2A 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
50-4 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.
13.3 Examples of Required Disclosures

ASC 718-10-55-134 through 55-137 contain examples that illustrate the disclosure requirements
described in ASC 718-10-50-1 through 50-2A (see Sections 13.1 and 13.2).
ASC 718-10
Example 9: Disclosure
55-134 This Example illustrates disclosures (see paragraphs 718-10-50-1 through 50-2) 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.
498
55-135 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.
Case A: Share Option Plan

55-136 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.
20Y1 20Y0 20Y9
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%
499
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.
Weighted-
Weighted- Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Options Shares (000) Price Term 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.
Weighted-Average
Nonvested Shares Shares (000) 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 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.
500
Case B: Performance Share Option Plan

55-137 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.
Weighted-
Weighted- Average
Average Remaining Aggregate
Exercise Contractual Intrinsic
Performance Options Shares (000) Price Term 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.
501
13.4 Interim Reporting
ASC 270-10
Accounting Principles and Practices

45-1 Interim financial information is essential to provide investors and others with timely information as to the
progress of the entity. The usefulness of such information rests on the relationship that it has to the annual
results of operations. Accordingly, each interim period should be viewed primarily as an integral part of an
annual period.
Disclosure of Summarized Interim Financial Data by Publicly Traded Companies

50-1 Many publicly traded companies report summarized financial information at periodic interim dates in
considerably less detail than that provided in annual financial statements. While this information provides
more timely information than would result if complete financial statements were issued at the end of each
interim period, the timeliness of presentation may be partially offset by a reduction in detail in the information
provided. As a result, certain guides as to minimum disclosure are desirable. (It should be recognized that
the minimum disclosures of summarized interim financial data required of publicly traded companies do
not constitute a fair presentation of financial position and results of operations in conformity with generally
accepted accounting principles [GAAP].) If publicly traded companies report summarized financial information
at interim dates (including reports on fourth quarters), the following data should be reported, as a minimum: . . .
g. Changes in accounting principles or changes in accounting estimates (see paragraphs 270-10-45-12
through 45-16)
h. Significant changes in financial position (see paragraph 270-10-50-4) . . . .
50-2 If interim financial data and disclosures are not separately reported for the fourth quarter, users of the
interim financial information often make inferences about that quarter by subtracting data based on the third
quarter interim report from the annual results. In the absence of a separate fourth quarter report or disclosure
of the results (as outlined in the preceding paragraph) for that quarter in the annual report, disposals of
components of an entity and unusual or infrequently occurring items recognized in the fourth quarter, as well
as the aggregate effect of year-end adjustments that are material to the results of that quarter (see paragraphs
270-10-05-2 and 270-10-45-10) shall be disclosed in the annual report in a note to the annual financial
statements. If a publicly traded company that regularly reports interim information makes an accounting
change during the fourth quarter of its fiscal year and does not report the data specified by the preceding
paragraph in a separate fourth quarter report or in its annual report, the disclosures about the effect of the
accounting change on interim periods that are required by paragraphs 270-10-45-12 through 45-14 or by
paragraph 250-10-45-15, as appropriate, shall be made in a note to the annual financial statements for the
fiscal year in which the change is made.
50-3 Disclosure of the impact of the financial results for interim periods of the matters discussed in paragraphs
270-10-45-12 through 45-16 and 270-10-50-5 through 50-6 is desirable for as many subsequent periods as
necessary to keep the reader fully informed. There is a presumption that users of summarized interim financial
data will have read the latest published annual report, including the financial disclosures required by generally
accepted accounting principles (GAAP) and management’s commentary concerning the annual financial
results, and that the summarized interim data will be viewed in that context. In this connection, management
is encouraged to provide commentary relating to the effects of significant events upon the interim financial
results.
50-4 Publicly traded companies are encouraged to publish balance sheet and cash flow data at interim dates
since these data often assist users of the interim financial information in their understanding and interpretation
of the income data reported. If condensed interim balance sheet information or cash flow data are not
presented at interim reporting dates, significant changes since the last reporting period with respect to liquid
assets, net working capital, long-term liabilities, or stockholders’ equity shall be disclosed.
502
ASC 718-10-50-1 states that the disclosure requirements for annual periods (see Sections 13.1 and
13.2) are not required for interim periods. In addition, ASC 718 does not specify the requirements for
share-based compensation disclosures in interim financial statements. However, paragraph B239 of the
Basis for Conclusions of FASB Statement 123(R) refers to the requirements for disclosing “information
about changes in accounting principles or estimates and significant changes in financial position,” which
were codified in ASC 270-10-50-1.
Paragraph B239 of Statement 123(R) also notes that when “share-based compensation cost is significant
[registrants] may wish to provide additional information, including the total amount of that cost, on
a quarterly basis.” This may apply to registrants that grant a substantial portion of their share-based
payment awards at a single time each year.
In addition, SEC Regulation S-X, Rule 10-01(a)(5), requires registrants to disclose in their quarterly
financial statements information that is “sufficient so as to make the interim information presented not
misleading.” When assessing the volume and type of information to be disclosed in quarterly financial
statements, registrants should consider factors such as the amount and timing of grants of share-
based payment awards, material modifications to existing share-based payment awards, material share
repurchases, material changes in assumptions used in the valuation of awards, and material changes to
the type of awards issued.
13.5 Subsidiary Disclosures
SAB Topic 1.B.1, Allocation of Expenses and Related Disclosure in Financial Statements of Subsidiaries,
Divisions or Lesser Business Components of Another Entity: Costs Reflected in Historical Income
Statements [Excerpt; Reproduced in ASC 220-10-S99-3]
Facts: A company (the registrant) operates as a subsidiary of another company (parent). Certain expenses
incurred by the parent on behalf of the subsidiary have not been charged to the subsidiary in the past. The
subsidiary files a registration statement under the Securities Act of 1933 in connection with an initial public
offering.
Question 1: Should the subsidiary’s historical income statements reflect all of the expenses that the parent
incurred on its behalf?
Interpretive Response: In general, the staff believes that the historical income statements of a registrant
should reflect all of its costs of doing business. Therefore, in specific situations, the staff has required the
subsidiary to revise its financial statements to include certain expenses incurred by the parent on its behalf.
Examples of such expenses may include, but are not necessarily limited to, the following (income taxes and
interest are discussed separately below):
1. Officer and employee salaries,
2. Rent or depreciation,
3. Advertising,
4. Accounting and legal services, and
5. Other selling, general and administrative expenses.
When the subsidiary’s financial statements have been previously reported on by independent accountants and
have been used other than for internal purposes, the staff has accepted a presentation that shows income
before tax as previously reported, followed by adjustments for expenses not previously allocated, income taxes,
and adjusted net income.
A subsidiary must comply with the disclosure requirements of ASC 718-10-50 in its stand-alone financial
statements. SAB Topic 1.B.1 notes that a registrant (subsidiary) should reflect all the costs of doing
business in the subsidiary’s financial statements (to help financial statement users understand such
503
costs). SAB Topic 1.B.1 also requires a registrant to reflect expenses incurred by a parent on behalf
of its subsidiary in the historical financial statements of the subsidiary and provides examples of such
expenses.
In determining what to disclose in their stand-alone financial statements, subsidiaries (regardless of

whether they are SEC registrants) should apply the same requirement as that in SAB Topic 1.B.1. In
addition, subsidiaries’ disclosures should be similar to those of their parent.
13.6 Nonemployee Awards
The disclosure requirements in ASC 718-10-50-1 and 50-2 apply to nonemployee awards. As noted in
ASC 718-10-50-2(g), an entity must consider whether it should provide the disclosures required by ASC
718-10-50-2(a)–(f) separately for employee and nonemployee awards if the differences between the
awards’ characteristics are important to an investor’s understanding of them.
13.7 Change in Valuation Techniques

ASC 718-10
Consistent Use of Valuation Techniques and Methods for Selecting Assumptions

55-27 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.

Question 3: In subsequent periods, may a company change the valuation technique or model chosen to value
instruments with similar characteristics?26
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.27 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. 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.28 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.29
26
FASB ASC paragraph 718-10-55-17 indicates that an entity may use different valuation techniques or models for
instruments with different characteristics.
27
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.
28
29
See generally FASB ASC paragraph 718-10-50-1.
504
ASC 718-10-55-27 states, in part, that the “valuation technique an entity selects . . . shall be used
consistently and shall not be changed unless a different valuation technique is expected to produce a
better estimate of fair value.” It also states that a change in valuation technique should be accounted for
as a change in accounting estimate under ASC 250 and applied prospectively to new awards. In addition,
Question 3 of SAB Topic 14.C states that the SEC staff would not object to a change in an entity’s
valuation technique or model as long as the new technique or model meets the fair value measurement
objective of ASC 718.
ASC 250-10-50-5 indicates that entities do not need to disclose the information required by ASC 250-10-
50-4 for a change in estimate that results from a change in valuation technique. However, SAB Topic
14.C states that for a share-based payment award, “[d]isclosure in the footnotes of the basis for any
change in technique or model would be appropriate.” Accordingly, entities are encouraged to disclose
the basis for a change in their technique for valuing share-based payment awards. In addition, SEC
registrants may consider additional disclosures in MD&A if the change in estimate materially affected the
entity’s results of operations.
13.8 Transition From Nonpublic to Public Entity Status

Question 4 of SAB Topic 14.B discusses the SEC staff’s views on the disclosure requirements for share-
based payment awards during an entity’s transition from nonpublic to public entity status (e.g., when
filing its initial registration statement with the SEC).
SAB Topic 14.B, Transition From Nonpublic to Public Entity Status [Excerpt; Reproduced in ASC 718-10-S99-1]
Facts: Company A is a nonpublic entity8 that first files a registration statement with the SEC to register its
equity securities for sale in a public market on January 2, 20X8.9 As a nonpublic entity, Company A had been
assigning value to its share options10 under the calculated value method prescribed by FASB ASC Topic 718,
Compensation — Stock Compensation,11 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. . . .
Question 4: Upon becoming a public entity, what disclosures should Company A consider in addition to those
prescribed by FASB ASC Topic 718?18
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.19 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 applicability of SEC Release No. FR-6020 and Section V, “Critical Accounting Estimates,” in SEC
Release No. FR-7221 regarding critical accounting policies and estimates in MD&A.

8
Defined in the FASB ASC Master Glossary.
9
For the purposes of these illustrations, assume all of Company A’s equity-based awards granted to its employees were
granted after the adoption of FASB ASC Topic 718.
10
For purposes of this staff accounting bulletin, the phrase “share options” is used to refer to “share options or similar
instruments.”
505
11
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
18
19
See generally SEC Release No. FR-72, “Commission Guidance Regarding Management’s Discussion and Analysis of
Financial Condition and Results of Operations.”
20
SEC Release No. FR-60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies.”
21
SEC Release No. FR-72, “Commission Guidance Regarding Management’s Discussion and Analysis of Financial Condition
and Results of Operations.”
SEC Financial Reporting Manual
9520 Share-Based Compensation in IPOs

9520.1 Estimates used to determine share-based compensation are often considered critical by companies
going public. In particular, estimating the fair value of the underlying shares can be highly complex and
subjective because the shares are not publicly traded. The staff will consider if a company performing these
estimates is providing the following critical accounting estimate disclosures in its IPO prospectus:
a. The methods that management used to determine the fair value of the company’s shares and the
nature of the material assumptions involved. For example, companies using the income approach
should disclose that this method involves estimating future cash flows and discounting those cash flows
at an appropriate rate.
b. The extent to which the estimates are considered highly complex and subjective.
c. The estimates will not be necessary to determine the fair value of new awards once the underlying
shares begin trading.
Companies may cross-reference to the extent that this, or other material information relevant to share-based
compensation, is provided elsewhere in the prospectus.
9520.2 The staff may issue comments asking companies to explain the reasons for valuations that appear
unusual (e.g., unusually steep increases in the fair value of the underlying shares leading up to the IPO). These
comments are intended to elicit analyses that the staff can review to assist it in confirming the appropriate
accounting for the share-based compensation, not for the purpose of requesting changes to disclosure in the
MD&A or elsewhere in the prospectus.
9520.3 The staff will also consider other MD&A requirements related to share-based compensation, including
known trends or uncertainties including, but not limited to, the expected impact on operating results and taxes.
Typically, a registrant undergoing an IPO of its equity securities identifies share-based compensation
as a critical accounting estimate because the lack of a public market for the pre-IPO shares makes the
estimation process complex and subjective.
Further, paragraph 7520.1 of the FRM outlines considerations related to the “estimated fair value of
[stock that] is substantially below the IPO price” (often referred to as “cheap stock”). Registrants should
be able to reconcile the change in the estimated fair value of the underlying equity between the award
grant date and the IPO by taking into account, among other things, intervening events and changes in
assumptions that support the change in fair value.
506
The SEC staff had historically asked registrants to expand the disclosures in their critical accounting
estimates to add information about the valuation methods and assumptions used for share-based
compensation in an IPO. In 2014, however, it updated Section 9520 of the FRM to indicate that
registrants should significantly reduce, in the critical accounting estimates section of MD&A, their
disclosures about share-based compensation and the valuation of pre-IPO common stock. Nevertheless,
paragraph 9520.2 of the FRM notes that the SEC staff may continue to request that companies “explain
the reasons for valuations that appear unusual (e.g., unusually steep increases in the fair value of the
underlying shares leading up to the IPO).” Such requests are meant to ensure that a registrant’s analysis
and assessment support its accounting for share-based compensation; they do not necessarily indicate
that the registrant’s disclosures need to be enhanced.
At the Practising Law Institute’s “SEC Speaks in 2014” Conference, the SEC staff discussed the types of
detailed disclosures it had observed in IPO registration statements that had prompted the updates to
Section 9520 of the FRM. The staff noted that registrants have historically included:
• A table of equity instruments issued during the past 12 months.

• A description of the methods used to value the registrant’s pre-IPO common stock (i.e., income
approach or market approach).
• Detailed disclosures about certain select assumptions used in the valuation.

• Discussion of changes in the fair value of the company’s pre-IPO common stock, which included
each grant leading up to the IPO and resulted in repetitive disclosures.
The staff indicated that despite the volume of share-based compensation information included in IPO
filings, disclosures of such information were typically incomplete because registrants did not discuss all
assumptions related to their common stock valuations. Further, disclosures about registrants’ pre-IPO
common stock valuations were not relevant after an IPO and were generally removed from their
periodic filings after the IPO. The SEC staff expressed the view that in addition to reducing the volume of
information, streamlined share-based compensation disclosures also make reporting more meaningful.
The staff also indicated that by eliminating unnecessary information, registrants could reduce “down to
one paragraph” many of their prior disclosures.
At the conference, the SEC staff also provided insights into how registrants would be expected to apply
the guidance in paragraph 9520.1 of the FRM (and thereby reduce the share-based compensation
disclosures in their IPO registration statements):
• The staff does not expect much detail about the valuation method registrants used to determine
the fair value of their pre-IPO shares. A registrant need only state that it used the income
approach, the market approach, or a combination of both.
Further, while registrants are expected to discuss the nature of the material assumptions they
used, they would not be required to quantify such assumptions. For example, if a registrant
used an income approach involving a discounted cash flow method, it would only need to
provide a statement that a discounted cash flow method was used and involved cash flow
projections that were discounted at an appropriate rate. No additional details would be needed.
• Registrants would have to include a statement indicating that the estimates in their share-based
compensation valuations are highly complex and subjective but would not need to provide
additional details about the estimates. Registrants would also need to include a statement
disclosing that such valuations and estimates will no longer be necessary once the entity goes
public because it will then rely on the market price to determine the fair value of its common
stock.
507
The staff emphasized that its ultimate concern is whether registrants correctly accounted for
pre-IPO share-based compensation. Accordingly, the staff will continue to ask them for supplemental
information to support their valuations and accounting conclusions — especially when the fair value of
a company’s pre-IPO common stock is significantly less than the expected IPO price.1 See Section 4.12.1
for additional considerations related to cheap stock.
13.9 MD&A Disclosures — Expected Volatility

Question 5 of SAB Topic 14.D.1 presents the SEC staff’s views on the disclosures about expected
volatility related to share-based payment awards that registrants would be expected to provide in their
financial statements and MD&A.
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 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.57 Under that guidance, Company B is required to disclose the
expected volatility and the method used to estimate it.58 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.
In addition, Company B should consider the applicability of SEC Release No. FR-60 and Section V, “Critical
Accounting Estimates,” in SEC Release No. FR-72 regarding critical accounting policies and estimates in MD&A.
The staff would expect such disclosures to include an explanation of the method used to estimate the expected
volatility of its share price. This explanation generally should include a discussion of the basis for the company’s
conclusions regarding the extent to which it used historical volatility, implied volatility or a combination of both.
A company could consider summarizing its evaluation of the factors listed in Questions 2 and 3 of this section
as part of these disclosures in MD&A.

57

58
1
At the conference, the SEC staff noted that valuations that appear to be unusual may be attributable to the peer companies selected when a
market approach is used. Specifically, the staff indicated that there are often inconsistencies between the peer companies used by registrants
and those used by the underwriters, which result in differences in the valuations. Accordingly, the staff encouraged registrants to talk to the
underwriters “early and often” to avoid such inconsistencies.
508
Chapter 14 — Accounting for Share-Based
Payments Issued as Sales Incentives to
Customers
14.1 Background
Recognition of share-based payments issued to a customer that are not in exchange for a distinct good
or service (i.e., share-based sales incentives) is outside the scope of ASC 718 and must be accounted
for under ASC 606. While ASC 606 addresses the recognition of share-based sales incentives (i.e., as a
reduction of revenue), it does not provide guidance on the measurement (or measurement date) of such
incentives. Measurement and classification of share-based sales incentives is subject to the guidance in
ASC 718.
14.2 Overview
The guidance in ASC 718 on measuring and classifying share-based sales incentives requires entities
to use a fair-value-based measure to calculate such incentives on the grant date. The grant date is the
date on which the grantor (the entity) and the grantee (the customer) reach a mutual understanding of
the key terms and conditions of the share-based consideration. The result is reflected as a reduction
of revenue in accordance with the guidance in ASC 606 on consideration payable to a customer. After
initial recognition, the measurement and classification of the share-based sales incentives continue to
be subject to ASC 718 unless (1) the award is subsequently modified when vested and (2) the grantee is
no longer a customer.
14.3 Scope
ASC 718-10
Transactions
instruments.
509
606-10-32-26.
ASC 606-10
32-25 Consideration payable to a customer includes:

a. Cash amounts that an entity pays, or expects to pay, to the customer (or to other parties that purchase
the entity’s goods or services from the customer)
b. Credit or other items (for example, a coupon or voucher) that can be applied against amounts owed to
the entity (or to other parties that purchase the entity’s goods or services from the customer)
c. Equity instruments (liability or equity classified) granted in conjunction with selling goods or services (for
example, shares, share options, or other equity instruments).
An entity shall account for consideration payable to a customer as a reduction of the transaction price and,
therefore, of revenue unless the payment to the customer is in exchange for a distinct good or service
(as described in paragraphs 606-10-25-18 through 25-22) that the customer transfers to the entity. If the
consideration payable to a customer includes a variable amount, an entity shall estimate the transaction
price (including assessing whether the estimate of variable consideration is constrained) in accordance with
paragraphs 606-10-32-5 through 32-13.
ASC 718 applies to share-based payments granted in conjunction with the sale of goods and services
to a customer that are not in exchange for a distinct good or service. However, entities apply ASC 718
only to measure and classify share-based sales incentives, and they reflect the measurement of such
incentives as a reduction of the transaction price and recognize it in accordance with the guidance in
ASC 606 on consideration payable to a customer. Entities that receive distinct goods or services from a
customer should account for the share-based payment in the same manner as they account for other
purchases from suppliers (i.e., by applying the guidance in ASC 718). Any excess of the fair-value-based
measure of the share-based payment award over the fair value of the distinct goods or services received
should be reflected as a reduction to the transaction price and recognized in accordance with the
guidance in ASC 606 on consideration payable to a customer.
See Chapter 6 of Deloitte’s Roadmap Revenue Recognition for additional guidance on consideration
Connecting the Dots

ASC 718 applies to share-based sales incentives issued to customers under ASC 606 and
therefore does not directly address similar equity-based incentives issued by a lessor to a lessee
under ASC 840 or ASC 842.1
1
See paragraph BC17 of ASU 2019-08.
510
Chapter 14 — Accounting for Share-Based Payments Issued as Sales Incentives to Customers
14.4 Initial Measurement
ASC 606-10
32-25A Equity instruments granted by an entity in conjunction with selling goods or services shall be measured
and classified under Topic 718 on stock compensation. The equity instrument shall be measured at the grant
date in accordance with Topic 718 (for both equity-classified and liability-classified share-based payment
awards). Changes in the measurement of the equity instrument (through the application of Topic 718) after
the grant date that are due to the form of the consideration shall not be included in the transaction price. Any
changes due to the form of the consideration shall be reflected elsewhere in the grantor’s income statement.
See paragraphs 606-10-55-88A through 55-88B for implementation guidance on equity instruments granted as
consideration payable to a customer.
Share-based sales incentives are reflected as a reduction in the transaction price on the basis of
the grant-date fair-value-based measure in accordance with ASC 718 (for both equity- and liability-
classified awards). In addition, share-based sales incentives may contain vesting conditions (i.e., service
or performance conditions that must be satisfied for the customer to vest in an award) or conditions
that affect factors other than the vesting of an award (i.e., market conditions, service or performance
conditions that affect factors other than vesting or exercisability, or “other” conditions that do not
meet the definition of a service, performance, or market condition). Both vesting and nonvesting
conditions should be evaluated in accordance with ASC 718, which specifies that vesting conditions,
unlike nonvesting conditions, are not directly factored into the fair-value-based measure of the award.
Therefore, the amount recognized as a share-based sales incentive would (1) reflect the actual outcome
of any vesting condition and (2) incorporate in its measurement any nonvesting conditions.
Connecting the Dots

An entity is required to use judgment when determining whether a vesting condition related to a
share-based sales incentive is a service condition or a performance condition.
The recognition of a share-based sales incentive with a service condition that affects vesting will
depend on the entity’s accounting policy for forfeitures of nonemployee share-based payment
awards. For example, if the entity elects to estimate forfeitures, it bases its estimate of the share-
based sales incentive on the probable outcome for both service and performance conditions.
However, if the entity elects to recognize forfeitures when they occur, it reflects the entire share-
based sales incentive with a service condition that affects vesting in the transaction price unless
Many share-based sales incentives include conditions that are tied to customer purchase levels
(or to a customer’s remaining purchases for a specified period). We believe that such conditions
are akin to service conditions.
511
Example 14-1
Share-Based Sales Incentive Issued for Each Purchase

On January 1, 20X1, Entity A executes a one-year master supply agreement (MSA) to sell and deliver widgets
to Customer B. The MSA includes general terms and conditions but does not contain any minimum purchase
requirements. Accordingly, legally enforceable rights and obligations associated with a revenue contract
between A and B do not exist until B issues a purchase order for a specific number of widgets. In other words,
the criteria in ASC 606-10-25-1 that must all be met for an entity to conclude that a contract with a customer
exists are only met each time B issues a subsequent purchase order under the MSA.
Customer B agrees to pay A $1,000 for each widget purchased under the MSA. As a share-based sales
incentive, A includes terms in the MSA that grant B 500 fully vested shares of A’s common stock for each widget
that B purchases. The share-based sales incentive is not in exchange for distinct goods or services. Entity B
issues three separate purchase orders, each for one widget, on January 31, March 1, and December 31, 20X1.
On the same day on which A receives each purchase order, it transfers control of each widget to B and also
issues to B 500 shares of A’s common stock in fulfillment of the terms of the MSA.
The fair value of A’s common stock is $1.00 per share on January 1, 20X1, and appreciates during 20X1 as
follows:
Entity A Common
Stock Fair Value
Date (per Share)
January 1, 20X1 $ 1.00
January 31, 20X1 $ 1.05
March 1, 20X1 $ 1.50
December 31, 20X1 $ 2.00
Entity A concludes that the terms of the MSA are sufficient to establish a grant date for the share-based sales
incentive in accordance with the guidance in ASC 718. Entity A measures the share-based sales incentive issued
to B on January 1, 20X1, because a grant date exists for the share-based sales incentive in accordance with the
criteria in ASC 718. For each separately sold widget, A will thus recognize revenue reduced by the grant-date fair-
value-based measure of the share-based sales incentive of $500 (500 shares × $1.00), measured as of January 1,
20X1. Accordingly, A will recognize the following revenue during 20X1:
January 31, March 1, December

20X1 20X1 31, 20X1 Total
Revenue $ 1,000 $ 1,000 $ 1,000 $ 3,000
Less: share-based
sales incentive 500 500 500 1,500
Net revenue $ 500 $ 500 $ 500 $ 1,500
Entity A will classify the share-based sales incentive in accordance with the guidance in ASC 718. Likewise, A will
continue to apply ASC 718 to classify and measure the share-based sales incentive unless it is subsequently
modified when it vests and B is no longer a customer. Although there are changes to the fair-value-based
measure of the common stock after the grant date, if the award remains within the scope of ASC 718 and is
not modified, there is no accounting effect for those changes because the measurement date for an equity-
classified award is the grant date.
512
Example 14-2
Share-Based Sales Incentive Contingent on Cumulative Purchases

Assume the same facts as in the example above except that Customer B will earn 1,000 shares of Entity A’s
common stock when it purchases five widgets within one year of the MSA’s execution. Entity A concludes that
the share-based sales incentive includes a service condition and applies its policy election under ASC 718-10-
35-1D for nonemployee share-based payment awards to recognize forfeitures as they occur. Entity A calculates
the reduction in transaction price as $1,000 (1,000 shares × $1 grant-date fair-value-based measure), which A
will recognize with the related revenue. If at the end of 20X1 B has purchased five or more widgets, there is no
effect on the total reduction in transaction price. By contrast, if at the end of 20X1 B has purchased fewer than
five widgets and therefore forfeits the share-based sales incentive, A will reverse the portion of the $1,000 that
it previously recorded as a reduction of revenue.
While vesting and nonvesting conditions are not subject to the variable consideration guidance in ASC
606, such guidance could still be applicable in certain circumstances. For example, an entity should
apply ASC 606-10-32-7 and estimate the fair-value-based measure of an equity instrument before the
grant date when a grant date has not been established but (1) the customer has a valid expectation
that a share-based sales incentive will be issued (e.g., because of an entity’s history of issuing share-
based sales incentives or its ongoing negotiations related to the issuance of a share-based sales
incentive for which the terms of the equity instruments have not yet been finalized) or (2) other facts
and circumstances indicate that the entity intends to issue a share-based sales incentive. In the period
in which a grant date is established, the entity adjusts the transaction price for the cumulative effect of
calculating the fair-value-based measure on the grant date. This treatment is similar to the accounting
applied when the service inception date precedes the grant date for employee awards.2 For example, an
entity could enter into a revenue contract with a customer for the purchase of goods or services while
negotiating a share-based sales incentive with that customer. If a grant date has not been established
for that award because the terms are still being negotiated, the entity would be required to estimate
the fair-value-based measure of the award and reflect that estimate (or a portion of the estimate) as a
reduction of the transaction price. That estimate will be adjusted in each reporting period until a grant
date has been established.
14.5 Classification
As discussed above, the classification of share-based sales incentives is subject to the guidance in ASC
718. Therefore, an entity applies ASC 718-10-25-6 through 25-19A to determine whether an award
is classified as equity or a liability. As in the case of other nonemployee awards, if (1) the award is
subsequently modified when vested and (2) the grantee is no longer a customer, the award becomes
subject to other U.S. GAAP (e.g., ASC 480, ASC 815) unless the modification is made in conjunction with
an equity restructuring that meets certain conditions.3
See Chapter 5 for more information about determining whether an award is classified as equity or a
liability.
2
See Section 3.6.4.
3
See Section 5.8.
513
14.6 Subsequent Measurement and Presentation

ASC 718-10
35-1D 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
ASC 606-10
32-25A Equity instruments granted by an entity in conjunction with selling goods or services shall be measured
and classified under Topic 718 on stock compensation. The equity instrument shall be measured at the grant
date in accordance with Topic 718 (for both equity-classified and liability-classified share-based payment
awards). Changes in the measurement of the equity instrument (through the application of Topic 718) after
the grant date that are due to the form of the consideration shall not be included in the transaction price. Any
changes due to the form of the consideration shall be reflected elsewhere in the grantor’s income statement.
See paragraphs 606-10-55-88A through 55-88B for implementation guidance on equity instruments granted as
consideration payable to a customer.
Share-based sales incentives are measured on the grant date (for both equity-classified and liability-
classified share-based payments) in accordance with the guidance in ASC 718. In addition, under ASC
718, equity-classified awards are not remeasured, whereas liability-classified awards are remeasured
until settlement.
Further, since both vesting and nonvesting conditions should be evaluated under ASC 718, a change in
the probable or actual outcome of a service or performance condition that results in a change in the
measurement of the award should be reflected as a change in the transaction price.4 If an estimate is
required, an entity should estimate the total fair-value-based measure of the sales incentive (e.g., by
determining the number of equity instruments that it will be obligated to issue) and update that amount
until the award ultimately vests or is forfeited. See Sections 3.4.1 and 3.4.2 for further discussion of
service conditions and performance conditions, respectively.
By contrast, any changes in measurement that are due to the form of consideration are not reflected
as changes to the transaction price but instead are presented elsewhere in the income statement.
This includes changes to the fair-value-based measure of liability-classified awards that are not related
to service or performance conditions. If such changes are not due to the form of consideration (i.e.,
changes in the probable or actual outcome of a service or performance condition), they are reflected as
changes to the transaction price on the basis of the awards’ grant-date fair-value-based measure.
4
If an entity has elected as an accounting policy to recognize the effects of forfeitures for nonemployee share-based payment awards when they
occur, it would not assess the probable outcome of a service condition that affects the awards’ vesting. It would instead include the entire share-
based sales incentive in the transaction price unless the incentive is forfeited.
514
Connecting the Dots

While ASC 606-10-32-25A states that subsequent changes in measurement due to the form of
the consideration should not be included in the transaction price (i.e., should not be presented
as an adjustment to revenue), it does not specify where such changes should be reflected in
the income statement. Therefore, an entity would use judgment to determine the appropriate
presentation in such circumstances.
14.6.1 Equity-Classified Share-Based Payments

ASC 718 requires that entities measure equity-classified share-based payment awards on the grant
date and not remeasure them unless the awards are modified. Entities should determine the grant-
date fair-value-based measure of the award on the basis of the probable or actual outcomes of any
service or performance conditions (whether vesting or nonvesting). The probable or actual outcomes
are reassessed in each reporting period, and the final measurement of the award associated with
the ultimate outcomes of those conditions will be reflected as a reduction of the transaction price.
Therefore, any changes to the total measurement of a share-based sales incentive would not be
attributable to the form of consideration and should be recognized as a change to the transaction price.
Example 14-3
Share-Based Sales Incentives That Include Both Service and Performance Conditions
On January 1, 20X1, Entity A sells 10,000 units of Product X to Customer B, a retailer, for $10 each (resulting in a
total sales value of $100,000). Assume that Entity A has elected to estimate forfeitures of nonemployee share-
based payment awards. The arrangement is within the scope of ASC 606.
As part of the arrangement, B promises to display Product X in a favorable location within its store to encourage
sales of Product X to the end consumer. In return for the favorable in-store placement of Product X, A grants
B 1,000 unvested equity-classified warrants on A’s common stock. The warrants have a term of five years and
a grant-date fair-value-based measure (as calculated under ASC 718) of $7 (resulting in a total grant-date fair-
value-based measure of $7,000). The warrants vest if B displays Product X in the favorable location for one
year. In addition, to protect A’s existing shareholders from dilution if A experiences poor financial results, the
warrants will vest only if A achieves a specified EBITDA target during the one-year vesting period.
Entity A determines the following:
• The grant date established for the warrants is January 1, 20X1.

• The requirement to provide favorable in-store placement of Product X for one year is a service condition,
and the specified EBITDA target is a performance condition.
• As of the grant date of the warrants, A estimates that it is probable that the warrants will vest under the
service and performance conditions.
• The benefit received from B (i.e., favorable in-store placement of Product X) in exchange for the warrants
does not represent a distinct good or service.
On the basis of the above determinations, A concludes that the warrants should be recognized as a reduction
of the transaction price for its sale of Product X to B (i.e., the warrants represent a share-based sales incentive).
To calculate the amount of that reduction, A considers that it is probable that the service and performance
conditions will be met. Therefore, on January 1, 20X1, A reduces the transaction price for its sale of Product X
to B by $7,000. If A determines that the share-based sales incentive is associated with the revenue from the
sale of the 10,000 units of Product X, the net revenue for those units will be $93,000 ($100,000 – $7,000). The
reduction in the transaction price would be reversed and reflected as an increase in the transaction price in a
subsequent reporting period if the warrants do not vest or it becomes probable that the warrants will not vest.
515
Example 14-4
Share-Based Sales Incentive That Includes a Performance Condition That Affects the Quantity of
Awards (Nonvesting Condition)
Assume the same facts as in the example above except that in this case, the performance condition affects the
quantity of the warrants earned instead of their vesting, and minimum, target, and maximum awards can be
earned depending on the level of the EBITDA target achieved. The table below shows the amount of warrants
that can be earned, as well as the resulting grant-date fair-value-based measure of the warrants, depending on
the relative achievement of the performance.
Total Grant-Date
Level of EBITDA Quantity of Fair-Value-Based
Target Achieved Warrants Measure of Warrants
50% (minimum) 500 $ 3,500
100% (target) 1,000 $ 7,000
150% (maximum) 1,500 $ 10,500
Entity A determines the following:
• The grant date established for the warrants is January 1, 20X1.

• The requirement to provide favorable in-store placement of Product X for one year is a service condition,
and the specified EBITDA target is a performance condition.
• As of the grant date of the warrants, A estimates that it is probable that the warrants will vest under the
service condition and that 1,000 warrants will be issued (in accordance with the target level) on the basis
of the probable outcome of the performance condition.
• The benefit received from Customer B (i.e., favorable in-store placement of Product X) in exchange for
the warrants does not represent a distinct good or service.
On the basis of the above determinations, A concludes that the warrants should be recognized as a reduction
of the transaction price for its sale of Product X to B (i.e., the warrants represent a share-based sales incentive).
To calculate the amount of that reduction, A considers that it is probable that the service condition will be met
and that the target performance condition resulting in the issuance of 1,000 warrants will be met. Therefore,
on January 1, 20X1, A reduces the transaction price for its sale of Product X to B by $7,000. If A determines that
the share-based sales incentive is associated with the revenue from the sale of the 10,000 units of Product
X, the net revenue for those units will be $93,000 ($100,000 – $7,000). The reduction in the transaction price
would be reversed and reflected as an increase in the transaction price in a subsequent reporting period if the
warrants do not vest or it becomes probable that the warrants will not vest under the service condition.
In addition, A would reflect as an adjustment to the transaction price a subsequent change in the measurement
of the warrants on the basis of the expected outcome or actual outcome of the performance condition. For
example, if A determines in a subsequent reporting period that the probable outcome is that 150 percent of
the EBITDA target will be achieved, which would result in a total grant-date fair-value-based-measurement of
$10,500, A would adjust the transaction price to reflect the revised grant-date fair-value-based measure of the
warrants (i.e., from $7,000 to $10,500) and record net revenue of $89,500 for Product X. The final reduction
in the transaction price would be based on the grant-date fair-value-based-measure of the ultimate outcome
achieved for both the service and performance conditions.
516
14.6.2 Liability-Classified Share-Based Payments

Under ASC 718, liability-classified share-based payment awards must be remeasured at the end of each
reporting period until settlement. However, ASC 606-10-32-25A requires that entities reflect only the
grant-date fair-value-based measure of a liability-classified share-based sales incentive as a reduction
of revenue. Any changes to the measurement of the share-based sales incentive after the grant date
that are attributable to the form of the consideration (i.e., not due to the probable or actual outcome
of any service or performance conditions) would be reflected elsewhere in the income statement.
Therefore, although entities would be required to remeasure liability-classified share-based sales
incentives at the end of each reporting period until settlement, they would not reflect as an adjustment
to revenue subsequent changes to the fair-value-based measure that are attributable to the form of the
consideration.
Example 14-5
Liability-Classified Share-Based Sales Incentive

Assume the same facts as in Example 14-3 except that instead of equity-classified warrants, Entity A grants
Customer B 1,000 cash-settled SARs that are liability classified. The grant-date fair-value-based measure is $7
(resulting in a total grant-date fair-value-based measure of $7,000). On December 31, 20X1, the fair-value-based
measure is $9 (resulting in a total fair-value-based measure of $9,000). Entity A concludes that it is probable
that the SARs will vest, and the SARs actually do vest, on December 31, 20X1.
On January 1, 20X1, A initially measures and reduces its transaction price for its sale of Product X to B by $7,000
(for net revenue of $93,000). On December 31, 20X1, the subsequent measurement of the award is $9,000.
This represents a change in the measurement of the award after the grant date that is attributable to the form
of consideration (changes in the fair-value-based measure of a liability-classified share-based payment award
that are unrelated to a change in service or performance conditions). Therefore, A does not revise its estimate
of the transaction price; rather, A reflects the change of $2,000 elsewhere in the income statement.
14.6.3 Practical Expedients for Nonpublic Entities

Except as noted below, under ASC 718 nonpublic entities may apply the same practical expedients to
share-based sales incentives as they apply to employee and nonemployee awards.
A nonpublic entity is permitted to use a practical expedient to measure all liability-classified share-based
payment awards for goods and services at intrinsic value instead of a fair-value-based measure. This
practical expedient must be applied consistently to both employee and nonemployee awards. However,
in accordance with ASC 718-30-30-2, a nonpublic entity’s initial and subsequent measurement of its
liability-classified share-based sales incentives should be calculated at the fair-value-based measure
even when the entity makes the intrinsic value measurement election for other liability-classified awards
within the scope of ASC 718.
For more information about measurement-related practical expedients available to nonpublic entities,
see Section 4.13.
517
14.7 Recognition
ASC 718-10
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.
An entity applies ASC 718 only to the measurement and classification of share-based sales incentives. To
recognize and present such incentives, the entity should apply the guidance in ASC 606 on consideration
For example, under ASC 606-10-32-27, an entity would recognize the grant-date fair-value-based
measure of share-based sales incentives as a reduction of revenue when (or as) the later of either of the
following events occurs:
a. The entity recognizes revenue for the transfer of the related goods or services to the customer.
b. The entity pays or promises to pay the consideration (even if the payment is conditional on a future
event). That promise might be implied by the entity’s customary business practices.
In accordance with the above guidance, an entity will typically recognize a share-based sales incentive as
a reduction of revenue when, or as, the entity recognizes revenue for the transfer of the related goods
or services to the customer.5 Because the vesting of share-based sales incentives may not align with the
recognition of revenue for the transfer of the related goods or services to the customer, an entity will
need to use judgment in those circumstances to determine what the “related” goods and services are.
See Chapter 8 of Deloitte’s Roadmap Revenue Recognition for additional guidance on determining when
to recognize revenue.6
Example 14-6
Recognition of Fully Vested Share-Based Sales Incentives

On January 1, 20X1, Entity A executes a one-year MSA to sell Product X to Customer B, a retailer, for $10 per
unit. The MSA includes general terms and conditions and also contains a minimum purchase requirement of
12,000 units (which establishes legally enforceable rights and obligations associated with the revenue contract),
resulting in a total minimum commitment of $120,000. The arrangement is within the scope of ASC 606.
5
As discussed in Section 14.4, there may be circumstances in which a grant date has not been established but the customer has a valid expectation
that share-based consideration will be issued. In such circumstances, the entity should apply the variable consideration guidance in ASC 606-10-
32-7 and estimate the fair-value-based measure of the equity instrument before the grant date.
6
See Chapter 6 of Deloitte’s Roadmap Revenue Recognition for additional guidance on the measurement and recognition of consideration payable
to a customer.
518
As incentive for B to agree to a minimum purchase commitment, A grants B 1,000 fully vested equity-classified
shares of A’s common stock. The shares have a grant-date fair-value-based measure of $10 (resulting in a total
grant-date fair-value-based measure of $10,000). The terms of the contract are sufficient to establish a grant
date of January 1, 20X1, for the shares.
Entity A concludes that it does not receive a distinct good or service in exchange for the shares and therefore
determines that it should account for the shares as a reduction of the transaction price for its sale of Product
X (i.e., the shares represent a share-based sales incentive). In addition, A determines that the up-front grant
of a fully vested share-based sales incentive with a grant-date fair-value-based measure of $10,000 meets the
definition of an asset.7 Entity A also determines that the share-based sales incentive is solely related to the
12,000 units of Product X in the initial contract on the basis of its best estimate of the probable amount of units
that B is expected to purchase.
Entity A measures and classifies the shares in accordance with ASC 718 and recognizes revenue (and the
reduction of revenue) for the share-based sales incentive payable in accordance with ASC 606. Because it
determined that the up-front fully vested share-based sales incentive meets the definition of an asset, A
recognizes an asset and corresponding credit to equity on the basis of the grant-date fair-value-based measure
of $10,000. The net transaction price is $110,000 ($120,000 – $10,000), and A subsequently amortizes the asset
as a reduction of revenue as the related goods or services are provided to the customer (i.e., as control of the
12,000 units of Product X transfers to the customer, with net revenue of approximately $9 per unit).
14.8 Disclosure
The FASB decided not to establish specific disclosure requirements for share-based sales incentives
because ASC 606 and ASC 718 already provide guidance on disclosures related to revenue transactions
and share-based payment arrangements. Accordingly, an entity should evaluate the disclosure
requirements in both ASC 606 and ASC 718 when it grants share-based sales incentives to customers.8
7
See Chapter 6 of Deloitte’s Roadmap Revenue Recognition for guidance on the recognition of up-front payments to customers.
8
See paragraph BC18 of ASU 2019-08.
519
Appendix A — Comparison of U.S. GAAP
and IFRS Standards
Under IFRS Standards, the primary source of guidance on the accounting for share-based payment
awards is IFRS 2. While ASC 718 and IFRS 2 share the same principles-based approach and are largely
converged, there are some differences in how entities apply those principles.
The table below summarizes some of the significant differences between U.S. GAAP and IFRS Standards
in the accounting for share-based payment awards.1 For detailed interpretive guidance on IFRS 2, see
A16, “Share-Based Payment,” of Deloitte’s iGAAP publication.
Accounting for Share-Based Payment Transactions

Subject U.S. GAAP IFRS Standards
Scope ASC 718 generally applies to share- IFRS 2 applies to share-based

based payment awards granted payment transactions with
to employees and nonemployees employees and nonemployees in
in exchange for goods or services. exchange for goods or services.
While the accounting for employee Under IFRS 2, the accounting
and nonemployee awards is largely treatment is different for (1) share-
aligned, differences in the guidance based payment awards granted
are discussed in Chapter 9. to employees and nonemployees
that provide services in a manner
similar to an employee and
(2) share-based payment awards
exchanged for goods or services
that are not similar to employee
services.
1
Differences are based on a comparison of authoritative literature under U.S. GAAP and IFRS Standards and do not necessarily include
interpretations of such literature.
520
Appendix A — Comparison of U.S. GAAP and IFRS Standards
(Table continued)
Subject U.S. GAAP IFRS Standards
Measurement of awards Share-based payment awards are Share-based payment awards

generally recognized at a fair-value- issued to nonemployees in
based measure (for both employee exchange for services that are
and nonemployee awards). similar to employee services are
measured on the same basis as
For awards granted by a nonpublic employee awards (i.e., a fair-value-
entity, the entity is required to based measure).
use a fair-value-based measure
or calculated value if it is not Share-based payment awards
practicable for it to estimate the issued to nonemployees in
expected volatility of its share price exchange for goods or for services
(see Section 4.13.2). In addition, that are not similar to employee
a nonpublic entity can make an services are measured as of the
entity-wide accounting policy date the entity obtains the goods
election to use either a fair-value- or the counterparty renders the
based measure (or a calculated service. The awards should be
value as noted above) or intrinsic measured on the basis of the fair
value to measure its liability- value of the goods or services
classified awards (see Section received unless that fair value
4.13.3). cannot be estimated reliably. If the
entity cannot estimate reliably the
fair value of the goods or services
received, the entity should measure
their value by reference to the fair
value of the equity instruments
granted. However, there is a
rebuttable presumption that the
fair value of the goods or services
received can be estimated reliably.
There are no practical expedients

for nonpublic entities. A fair-value-
based measure must be used for
all share-based payment awards.
Estimating the expected term If certain conditions are met, public There is no practical expedient for
of stock options and similar and nonpublic entities can apply a estimating the expected term or,
instruments practical expedient for estimating for nonemployee awards, election
the expected term (see Sections to use the contractual term as the
4.9.2.2.2 and 4.9.2.2.3). expected term.
In addition, for nonemployee

awards, an entity can make an
award-by-award election to use the
contractual term as the expected
term.
521
(Table continued)
Topic U.S. GAAP IFRS Standards
Contingent features Certain contingent features (i.e., A contingent feature is considered

clawback provisions) are excluded a nonvesting condition and
from the fair-value-based measure included in the fair value of the
and accounted for if and when award.
the contingent event occurs (see
Section 3.9).
Classification — risks and rewards A share-based payment award that A share-based payment award is
of equity share ownership for a can be repurchased for cash at fair recognized as a liability if there is
reasonable period of time value is not classified as a liability a present obligation to settle it in
if the grantee bears the risks and cash. There is no exception for a
rewards of equity share ownership grantee that bears the risks and
for a reasonable period of time (see rewards of share ownership for a
Section 5.3). reasonable period of time.
Classification of awards with “other” Awards with conditions or other Awards with conditions or other
conditions features that are indexed to features that are indexed to
something other than a market, something other than a market,
performance, or service condition performance, or service condition
must be classified as liabilities (see may be classified as equity if there
Section 5.5). is no obligation to settle the awards
in cash.
Classification of net-share- The net share settlement of an A net share settlement feature
settled awards with statutory tax employee award for statutory tax that permits or requires an entity
withholding obligations withholding purposes would not, by to withhold the number of equity
itself, result in liability classification instruments equal to the monetary
of the award provided that the value of the employee’s tax
amount withheld does not exceed obligation does not, by itself, result
the maximum statutory tax rates in liability classification. When the
in the employees’ relevant tax number of equity shares withheld
jurisdictions. If the amount withheld exceeds the number needed to
exceeds the maximum statutory tax settle the employee’s tax obligation,
rate, the entire award is classified only the excess is accounted for as
as a liability (see Section 5.7.2). a liability.
Classification of awards settled with Certain awards that are settled Awards that are settled with a
a variable number of shares with a variable number of shares variable number of shares are
are classified as a liability if classified as equity.
the monetary value is solely or
predominantly based on a fixed
monetary amount, variations in
something other than the fair
value of the entity’s equity shares,
or variations inversely related
to changes in the fair value of
the entity’s equity shares (see
Section 5.2).
522
(Table continued)
Attribution of employee awards An entity makes an accounting Such awards must be recognized
with service conditions and graded policy election to recognize only as in-substance multiple
vesting compensation cost for an awards (i.e., on an accelerated
employee award with only a service basis).
condition and a graded vesting
schedule on a straight-line basis
over either (1) the requisite service
period for each separately vesting
portion of the award as if the award
was, in substance, multiple awards
(i.e., on an accelerated basis) or
(2) the total requisite service period
for the entire award (see Section
3.6.5).
Performance targets satisfied after Performance conditions that Performance conditions that can
the requisite service period can be met after the requisite be met after the requisite service
service period or nonemployee’s period are treated as nonvesting
vesting period are treated as conditions. Therefore, the
vesting conditions. Therefore, the performance condition is directly
performance conditions are not reflected in the award’s fair-value-
directly reflected in an award’s fair- based measure.
value-based measure (see Section
3.4.2.2).
Share-based payment awards with A liquidity event such as a change For awards in which a liquidity
a performance condition based on in control or an IPO is generally event is assessed as a performance
the occurrence of a liquidity event not considered probable (i.e., condition, compensation cost is
(e.g., IPO or change in control) future event is likely to occur) recognized if or when the liquidity
until it occurs. This position is event is expected to occur.
consistent with the guidance in
ASC 805-20-55-50 and 55-51 on Often, it will not be possible to
liabilities that are triggered upon conclude that a liquidity event such
the consummation of a business as an IPO is expected to occur until
combination. Accordingly, an entity plans are well advanced.
generally does not recognize
compensation cost related to
awards that vest upon a change in
control or an IPO until the event
occurs.
Forfeitures of awards For service conditions, an entity An entity is required to estimate

makes an entity-wide accounting forfeitures expected to occur.
policy election (separately
for employee awards and
nonemployee awards) to either
(1) estimate the total number of
awards for which the requisite
service period or nonemployee’s
vesting period will not be rendered
(i.e., estimate forfeitures expected
to occur) or (2) account for
forfeitures when they occur (see
Section 3.4.1).
523
(Table continued)
Modification accounting for awards Compensation cost is recognized Compensation cost is recognized
for which vesting is improbable but on the basis of the modified on the basis of the grant-date
becomes probable award’s fair-value-based measure fair-value-based measure of the
as of the modification date (see original award plus the incremental
Section 6.3.3). value of the modified award on the
modification date.
Modification accounting for awards Upon modification, the liability Upon modification, the existing
that change from liability-classified is reclassified to equity. If the liability is derecognized. The fair-
to equity-classified fair-value-based measure of the value-based measure of the equity
modified award is less than the fair- awards on the modification date is
value-based measure of the liability recognized in equity on the basis
at the time of the modification, of which goods or services have
the difference is deemed to be a been received (i.e., on the basis of
capital contribution and recognized the vesting period that has lapsed).
in equity. If the fair-value-based Any difference between the liability
measure of the modified award derecognized and the amount
is greater than the fair-value- recognized in equity is reflected
based measure of the liability at immediately in the income
the time of the modification, the statement.
excess is generally recognized
as compensation cost over the
remaining employee’s requisite
service period or nonemployee’s
vesting period (see Section 6.8.2).
Accounting for income tax effects A DTA is recognized for When measuring the DTA, entities
tax-deductible awards on the basis must use the tax deduction that
of the GAAP expense recognized would be available on the basis of
and adjusted only when the related the current share price at the end
tax consequence occurs (e.g., of each reporting period.
upon exercise or vesting) for tax
purposes. Any excess tax benefits are
recognized when the estimated
All recognized income tax effects, tax deduction exceeds the
including any excess tax benefits, compensation expense recognized
are recorded in the income in the financial statements and are
statement (see Chapter 11). recorded in equity.
Recognition of payroll taxes Payroll tax liabilities related to Payments of payroll taxes are
share-based payment awards outside the scope of IFRS 2
should be recognized on the date because they are not payments to
on which the measurement and the suppliers of goods or services.
payment of the tax are triggered However, in a manner consistent
(e.g., upon exercise or vesting; see with the guidance in IAS 37, entities
Section 3.12). should recognize a liability for
them at the end of each reporting
period because they are similar to
cash-settled share-based payments
under IFRS 2.
524
(Table continued)
Group share-based payment Share-based payment awards Share-based payment awards

awards that are issued by a subsidiary to that are issued by a subsidiary to
employees or nonemployees of employees of the subsidiary and
the subsidiary and that are settled that are settled in the parent’s
in the parent’s equity are generally equity are generally classified as
classified as equity awards in the liability awards under IFRS 2 in the
stand-alone financial statements of stand-alone financial statements of
the subsidiary (see Section 2.9). the subsidiary unless the subsidiary
does not have an obligation to
Liability-classified awards (e.g., settle the awards.
cash-settled awards) that are
issued by a parent to employees or If a parent provides cash-settled
nonemployees of a subsidiary are awards to employees of a
generally remeasured at the end of subsidiary and the subsidiary
each period in the determination has no obligation to settle the
of compensation cost in the stand- awards, the awards are treated as
alone financial statements of the equity-settled awards in the stand-
subsidiary (i.e., the same amount of alone financial statements of the
compensation cost recognized by subsidiary.
the parent on a consolidated basis).
If the subsidiary has no obligation
associated with the awards, the
offset would be recognized as a
capital contribution in equity (see
Section 2.9).
Employee stock purchase plan The guidance in ASC 718-50 on The accounting requirements for
(ESPP) ESPPs may be different from that ESPPs are the same as those for
for other share-based payment all share-based payment awards.
awards (e.g., the requisite service Therefore, ESPPs are compensatory
period for ESPPs is the purchase and treated in the same manner
period). In addition, an ESPP may as any other equity-settled share-
be considered compensatory or based payment arrangement.
noncompensatory. To qualify as
a noncompensatory plan and,
therefore, not give rise to the
recognition of compensation
cost, an ESPP must meet certain
conditions (see Chapter 8).
525
Appendix B — Titles of Standards and
Other Literature
AICPA Literature
Accounting and Valuation Guide
Valuation of Privately-Held-Company Equity Securities Issued as Compensation
Technical Questions and Answers

Section 4110, “Issuance of Capital Stock”
FASB Literature
ASC Topics
ASC 210, Balance Sheet
ASC 235, Notes to Financial Statements
ASC 250, Accounting Changes and Error Corrections
ASC 260, Earnings per Share
ASC 270, Interim Reporting
ASC 310, Receivables
ASC 323, Investments — Equity Method and Joint Ventures
ASC 360, Property, Plant, and Equipment
ASC 450, Contingencies
ASC 470, Debt
ASC 480, Distinguishing Liabilities From Equity
ASC 505, Equity
ASC 606, Revenue From Contracts With Customers
ASC 610, Other Income
ASC 710, Compensation — General
ASC 718, Compensation — Stock Compensation
ASC 740, Income Taxes
526
Appendix B — Titles of Standards and Other Literature
ASC 805, Business Combinations
ASC 815, Derivatives and Hedging
ASC 820, Fair Value Measurement
ASC 835, Interest
ASC 840, Leases
ASC 842, Leases
ASC 855, Subsequent Events
ASUs
ASU 2014-09, Revenue From Contracts With Customers (Topic 606)
ASU 2016-09, Compensation — Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting
ASU 2017-09, Compensation — Stock Compensation (Topic 718): Scope of Modification Accounting
ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting
ASU 2019-08, Compensation — Stock Compensation (Topic 718) and Revenue From Contracts With
Customers (Topic 606): Codification Improvements — Share-Based Consideration Payable to a Customer
ASU 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
ASU 2021-04, Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity-Classified
Written Call Options (a consensus of the FASB Emerging Issues Task Force)
ASU 2021-07, Compensation — Stock Compensation (Topic 718): Determining the Current Price of an
Underlying Share
IFRS Literature
IAS 37, Provisions, Contingent Liabilities and Contingent Assets
IFRS 2, Share-Based Payment
IRC
Section 162(m), “Trade or Business Expenses; Certain Excessive Employee Remuneration”
Section 409A, “Inclusion in Gross Income of Deferred Compensation Under Nonqualified Deferred
Compensation Plans”
Section 421, “General Rules”
Section 422, “Incentive Stock Options”
Section 423, “Employee Stock Purchase Plans”
Section 424, “Definitions and Special Rules”
527
SEC Literature
Accounting Series Release (ASR)
No. 268 (FRR Section 211), Presentation in Financial Statements of “Redeemable Preferred Stocks”
Codified Financial Reporting Release

Section 211, “Redeemable Preferred Stocks”
Financial Releases
No. FR-60, “Cautionary Advice Regarding Disclosure About Critical Accounting Policies”
No. FR-72, “Commission Guidance Regarding Management’s Discussion and Analysis of Financial
Condition and Results of Operations”
FRM
Topic 7, “Related Party Matter”
Topic 9, “Management’s Discussion and Analysis of Financial Position and Results of Operations (MD&A)”
Regulation S-X
Rule 5-02, “Commercial and Industrial Companies; Balance Sheets”
Rule 7-03, “Insurance Companies; Balance Sheets”
Rule 9-03, “Bank Holding Companies; Balance Sheets”
Rule 10-01, “Interim Financial Statements”
SAB Topics
No. 1.B, “Financial Statements; Allocation of Expenses and Related Disclosure in Financial Statements of
Subsidiaries, Divisions or Lesser Business Components of Another Entity”
No. 3.C, “Senior Securities; Redeemable Preferred Stock”
No. 4.E, “Equity Accounts; Receivables From Sale of Stock”
No. 5.T, “Miscellaneous Accounting; Accounting for Expenses or Liabilities Paid by Principal
Stockholder(s)”
No. 14, “Share-Based Payment”

• No. 14.A, “Share-Based Payment Transactions With Nonemployees”
• No. 14.B, “Transition From Nonpublic to Public Entity Status”
• No. 14.C, “Valuation Methods”
• No. 14.D, “Certain Assumptions Used in Valuation Methods”
o No. 14.D.1, “Expected Volatility”
o No. 14.D.2, “Expected Term”
• No. 14.E, “FASB ASC Topic 718, Compensation — Stock Compensation, and Certain Redeemable
Financial Instruments”
528
Appendix B — Titles of Standards and Other Literature
• No. 14.F, “Classification of Compensation Expense Associated With Share-Based Payment

Arrangements”
• No. 14.I, “Capitalization of Compensation Cost Related to Share-Based Payment Arrangements”

Superseded Literature
Accounting Principles Board (APB) Opinion
No. 25, Accounting for Stock Issued to Employees
AICPA Accounting Interpretation

AIN-APB 25, Accounting for Stock Issued to Employees: Accounting Interpretations of APB Opinion No. 25
AICPA Accounting Statement of Position

SOP 76-3, Accounting Practices for Certain Employee Stock Ownership Plans
EITF Abstracts
Issue No. 00-23, “Issues Related to the Accounting for Stock Compensation Under APB Opinion No. 25
and FASB Interpretation No. 44”
Issue No. 08-8, “Accounting for an Instrument (or an Embedded Feature) With a Settlement Amount That
Is Based on the Stock of an Entity’s Consolidated Subsidiary”
FASB Interpretations
No. 28, Accounting for Stock Appreciation Rights and Other Variable Stock Option or Award Plans — an
interpretation of APB Opinions No. 15 and 25
No. 44, Accounting for Certain Transactions Involving Stock Compensation — an interpretation of APB
Opinion No. 25
FASB Staff Position (FSP)

FAS 123(R)-6, Technical Corrections of FASB Statement No. 123(R)
FASB Statements
No. 123(R), Share-Based Payment
No. 150, Accounting for Certain Financial Instruments With Characteristics of Both Liabilities and Equity
No. 157, Fair Value Measurements
FASB Technical Bulletin

No. 97-1, Accounting Under Statement 123 for Certain Employee Stock Purchase Plans With a Look-Back
Option
529
Appendix C — Abbreviations
Abbreviation Description Abbreviation Description
AICPA American Institute of Certified GAAP generally accepted accounting

Public Accountants principles
AIN-APB Accounting Interpretations of an GARCH Generalized Autoregressive

APB Opinion Conditional Heteroskedasticity
APB Accounting Principles Board IAS International Accounting Standard
APIC additional paid-in capital IFRS International Financial Reporting

Standard
ASC FASB Accounting Standards
Codification IPO initial public offering
ASR Accounting Series Release IRC Internal Revenue Code
ASU FASB Accounting Standards Update IRR internal rate of return
CEO chief executive officer IRS Internal Revenue Service
CFO chief financial officer ISO incentive stock option
CPI consumer price index LTIP long-term incentive plan
DLOM discount for lack of marketability MD&A Management’s Discussion and

Analysis
DRIP dividend reinvestment program
MSA master supply agreement
DTA deferred tax asset
NQSO or NSO nonqualified stock option
EBITDA earnings before interest, taxes,
depreciation, and amortization OEA SEC’s Office of Economic Analysis
EITF Emerging Issues Task Force PCAOB Public Company Accounting

Oversight Board
EPS earnings per share
PHLX Philadelphia Exchange
ESOARS employee stock option
appreciation rights securities RSU restricted stock unit
ESOP employee stock ownership plan SAB SEC Staff Accounting Bulletin
ESPP employee stock purchase plan SAR stock appreciation right
FASB Financial Accounting Standards SEC U.S. Securities and Exchange

Board Commission
FIFO first in, first out SOP AICPA Statement of Position
FRM SEC Division of Corporation S&P 500 Standard & Poor’s 500 stock
Finance’s Financial Reporting market index
Manual
TSR total shareholder return
FRR Financial Reporting Release
530
Appendix D — Roadmap Updates for 2021
The tables below summarize the substantive changes made in the 2021 edition of this Roadmap.
New Content
Section Title Description
On the Radar New section that briefly summarizes issues

and trends related to the accounting and
financial reporting topics addressed in the
Roadmap.
12.4.6 Employee Stock Purchase Plans Added Sections 12.4.6.1 through 12.4.6.3,
which provide guidance on employee stock
purchase plans and the impacts of those
arrangements on basic and diluted EPS.
Added Example 12-10.
Amended Content
2.2 Definition of Employee Added discussion of grantees who provide

services to pass-through entities.
2.4 Nonemployee Awards Added Connecting the Dots discussion

of the accounting implications of changes
in grantee status from employee to
nonemployee.
3.2.3 Unknown Conditions Expanded discussion of the establishment

of a grant date when there are unknown
factors related to market conditions. Added
Example 3-5A.
3.4.1.1 Estimating Forfeitures Added Example 3-7A, which addresses

the accounting for estimated forfeitures
and impacts associated with changes in
forfeiture estimates.
3.11.2 Nonrecourse Notes Added guidance on accounting for the

issuance of notes that are only collateralized
by shares of the company held by the
borrower.
531
(Table continued)
4.13.1 Application Added Changing Lanes discussion of ASU

2021-07, which gives nonpublic entities a
practical expedient allowing them to use
“the reasonable application of a reasonable
valuation method” to determine the current
price input of equity-classified share-based
payment awards issued to both employees
and nonemployees.
5.3 Share Repurchase Features Clarified that a right of first refusal is an

example of a contingent call option.
5.7.2 Statutory Tax Withholding Obligation Added discussion of tax withholdings on

behalf of grantees who meet the definition
of employees under common law but for
whom the entity does not have a statutory
obligation to withhold taxes.
5.10 SEC Guidance on Temporary Equity Added discussion of various option

arrangements and the impacts on
temporary equity classification.
6.1 Accounting for the Effects of Modifications Added Changing Lanes discussion of
ASU 2021-04, which provides guidance
on modifications of freestanding equity-
classified written call options and the
interaction between ASC 718 and ASC
815-40.
6.7 Short-Term Inducements Clarified that modification-date assessments

depend on whether grantees can withdraw
their acceptance of an inducement offer.
10.2.1.3.2 Allocation to Postcombination Vesting Clarified guidance on the allocation of

replacement awards between consideration
transferred and postcombination
compensation cost.
Deleted Content
Section Subject Description
9.10 through 9.20 Accounting for nonemployee awards before Removed guidance on the accounting
the adoption of ASU 2018-07 model before the adoption of ASU 2018-07
because all entities must have adopted the
ASU’s guidance by annual reporting periods
beginning after December 15, 2019.
532

Roadmap Series

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Roadmap Series

Uploaded by

Copyright:

Available Formats

Roadmap

Share-Based Payment Awards

Copyright © 2021 Deloitte Development LLC. All rights reserved.

Publications in Deloitte’s Roadmap Series

On the Radar  xvi

2.9 Separate Financial Statements 25

3.6.5 Graded Vesting for Employee Awards  81

Chapter 4 — Measurement 123

4.9 Option Pricing Models 150

Chapter 5 — Classification 212

5.4 Stock Options  233

Chapter 6 — Modifications 263

6.3.6 Modification of the Employee’s Requisite Service Period  291

Chapter 7 — Liability-Classified Awards 334

Chapter 8 — Employee Stock Purchase Plans 345

Chapter 9 — Nonemployee Awards 365

Chapter 10 — Business Combinations 393

Chapter 11 — Income Tax Accounting 431

Chapter 12 — Presentation 433

12.2 Statement of Operations 436

Chapter 13 — Disclosure 495

Chapter 14 — Accounting for Share-Based Payments Issued as Sales Incentives to

Appendix A — Comparison of U.S. GAAP and IFRS Standards 520

Appendix B — Titles of Standards and Other Literature 526

Appendix C — Abbreviations 530

Appendix D — Roadmap Updates for 2021 531

award state that it will be settled in shares of the entity?

Sean May Ashley Carpenter

Mark Crowley Jamie Davis

Sandie Kim Ignacio Perez

Aaron Shaw Stefanie Tamulis

Terms of a Share-Based Payment Award

Public Business Entity

ASC 718-10 — Glossary (continued)

1.7.4 Transition to Public Entity

1.8 Comparison With IFRS Standards

ASC 718-10 (continued)

Trust Unit Rights

Phantom Stock Plans

Identifying an Employee of a Physician Practice Management Entity

• Payment — “Payment by the hour, week, or month generally points to an employer-employee

Example 2: Definition of Employee

Connecting the Dots

2.5 Economic Interest Holders

ASC 718-10 — Glossary

Economic Interest in an Entity

2.5.1 Investor Purchases of Shares From Grantees

2.5.2 Share-Based Payments in an Economic Interest Holder’s Equity

Other Investors Entity A, Inc.

82% Ownership 3% Ownership

Account for in accordance with The award is, in substance, a

• Distribution rights, particularly after vesting.

• Provisions for realization of value.

Connecting the Dots

Plan Diversification Settlement Options Permitted Under Plan

A Not permitted Delivery of a fixed number of shares of employer stock

B Not permitted Delivery of cash or shares of employer stock

Connecting the Dots

2.7.1 Accounting for a Deferred Compensation Arrangement as Two Plans

2.7.2 Accounting for a Deferred Compensation Arrangement as One Plan

2.8 Consolidated Financial Statements

2.9 Separate Financial Statements

Parent’s Consolidated Subsidiary A’s Separate Subsidiary B’s Separate

If A does not reimburse

On the Radar xvi

2.9 Separate Financial Statements 25

3.6.5 Graded Vesting for Employee Awards 81

Chapter 4 — Measurement 123

4.9 Option Pricing Models 150

Chapter 5 — Classification 212

5.4 Stock Options 233

Chapter 6 — Modifications 263

6.3.6 Modification of the Employee’s Requisite Service Period 291

Chapter 7 — Liability-Classified Awards 334

Chapter 8 — Employee Stock Purchase Plans 345

Chapter 9 — Nonemployee Awards 365

Chapter 10 — Business Combinations 393

Chapter 11 — Income Tax Accounting 431

Chapter 12 — Presentation 433

12.2 Statement of Operations 436

Chapter 13 — Disclosure 495

Appendix A — Comparison of U.S. GAAP and IFRS Standards 520

Appendix B — Titles of Standards and Other Literature 526

Appendix C — Abbreviations 530

Appendix D — Roadmap Updates for 2021 531