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The acquirer may issue its own share-based payment awards (replacement awards) in exchange for awards held by grantees of the acquiree. Generally, in such a transaction, the acquirer will replace the existing awards (under which the grantees would have received shares of the acquiree) with awards that will be settled in shares of the acquirer. The purpose of this transaction may be to keep the grantees “whole” after the acquisition (i.e., preserve the value of the original awards at the acquisition date) or to provide further incentive for recipients to remain with the combined entity. Therefore, replacement awards may represent consideration for precombination vesting, postcombination vesting, or a combination of both. Replacement awards may contain the same terms as the original acquiree awards; other times, the acquirer may change the terms of the awards depending on its compensation strategy or other factors.
When the acquirer is obligated to grant replacement awards as part of a business combination, the replacement awards should be considered in the determination of the amount of consideration transferred for the acquiree. An acquirer is obligated to grant replacement awards if the acquiree or the acquiree’s grantees can legally require the acquirer to replace the awards. For purposes of applying this requirement, the acquirer is considered obligated to grant replacement awards in a business combination in accordance with ASC 805-30-30-9 if required by one of the following:
  • Terms of the acquisition agreement
  • Terms of the acquiree’s awards
  • Applicable laws or regulations
An exchange of share-based payment awards in a business combination is treated as a modification under ASC 718. The replacement awards and the original acquiree awards should both be measured at fair value at the acquisition date and calculated using the fair-value-based measurement principles in ASC 718. The guidance in ASC 805 is also applicable to acquiree and replacement awards valued using the calculated-value method or the intrinsic-value method, where permitted by ASC 718 for the acquirer. For simplicity, this chapter assumes that the share-based payment awards are measured at fair value under ASC 718.
Once the fair value of the awards has been determined, the replacement awards should be analyzed to determine whether the awards relate to precombination or postcombination vesting. To the extent replacement awards are for precombination vesting, the value of the awards should be allocated to consideration transferred to the sellers for the acquiree. To the extent replacement awards are for postcombination vesting, the value of the awards should be excluded from payments for the acquired business and recognized as compensation cost in the postcombination financial statements in accordance with ASC 805-30-30-11 through ASC 805-30-30-13 and ASC 805-30-55-7 through ASC 805-30-55-10. In many cases, awards issued to replace awards of the acquiree that are partially vested as of the acquisition date will be allocated between precombination and postcombination vesting, as described in BCG 3.4.1. As also noted in BCG 3.4.1, any incremental fair value of the replacement award in excess of the fair value of the original award at the acquisition date will be attributed to postcombination cost.
Acquiree awards may expire as a consequence of a business combination and the acquirer may not be obligated to grant replacement awards. In this situation, any replacement awards granted by the acquirer are considered separate from the business combination. Under ASC 805-30-30-10, the entire fair value of the replacement awards should be recognized as compensation cost in the postcombination financial statements.
Figure BCG 3-1 summarizes the accounting for different arrangements involving the exchange of awards held by the grantees of the acquiree in a business combination.
Figure BCG 3-1
The accounting for different arrangements involving the exchange of awards held by grantees of the acquiree in a business combination
Scenarios
Acquirer’s
obligation
Replacement of
awards
Expiration
of acquiree
awards


Accounting
1. The acquirer is obligated1 to issue replacement awards.
The acquirer issues replacement awards.
Not relevant.
The awards are considered in the determination of the amount of consideration transferred for the acquiree or for postcombination vesting.
2. The acquirer is not obligated1 to issue replacement awards to the acquiree.
The acquirer issues replacement awards.
The acquiree awards would otherwise expire.
The entire fair value of the replacement awards is recognized as compensation cost in the postcombination period.
3. The acquirer is not obligated1 to issue replacement awards to the acquiree.
The acquirer does not issue replacement awards. The acquiree awards remain outstanding postcombination as a noncontrolling interest.
The acquiree awards would not otherwise expire.
The acquirer could account for the continuation of the awards as if the acquirer was obligated to issue replacement awards (see Scenario 1 above).
Alternatively, the acquirer could account for the awards separate from the business combination as new grants and recognize the fair value of the awards as compensation cost in the postcombination period.
4. The acquirer is not obligated1 to issue replacement awards to the acquiree.
The acquirer issues replacement awards.
The acquiree awards would not otherwise expire.
Because the awards would not otherwise expire, if the acquirer had not issued replacement awards, the acquiree awards would have remained outstanding postcombination as a noncontrolling interest. The decision to issue replacement awards would then be viewed as an exchange of awards of the subsidiary (acquiree) for awards of the parent (acquirer), which is subject to modification accounting in accordance with ASC 718.
Therefore, similar to Scenario 3, the acquirer could account for the awards as if the acquirer was obligated to issue replacement awards. Alternatively, the acquirer could account for the awards separate from the business combination as new grants and recognize the fair value of the awards as compensation cost in the postcombination period.
1 An acquirer is obligated to issue replacement awards if required by the terms of the acquisition agreement, the terms of the acquiree’s awards, or applicable laws or regulations.

3.4.1 Fair value attributable to pre and postcombination vesting

For employee awards, the portion of employee replacement awards attributable to precombination vesting is the fair value of the acquiree awards multiplied by the ratio of the precombination employee’s requisite service period completed prior to the exchange to the greater of the total requisite service period of the replacement awards or the original requisite service period of the acquiree awards, in accordance with ASC 805-30-55-8 through ASC 805-30-55-9.
The fair value of the employee awards to be attributed to postcombination vesting would then be calculated by subtracting the portion attributable to precombination vesting from the total fair value of the acquirer replacement awards under ASC 805-30-55-10. Excess fair value, which is the incremental amount by which the fair value of the replacement awards exceeds the fair value of the acquiree awards on the acquisition date, should be attributed to postcombination vesting. The fair value attributable to precombination vesting should be reduced to reflect an estimate of future forfeitures, notwithstanding the acquirer’s policy for accounting for forfeitures. See ASC 805-30-55-17 through ASC 805-30-55-24 for examples and additional information.
For nonemployee awards, the portion of nonemployee replacement awards 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 the percentage that would have been recognized based on the original vesting requirements of the nonemployee award or the percentage that would have been recognized based on the effective vesting requirements (i.e., goods or services provided before the acquisition date plus any additional postcombination goods or services required by the replacement award) in accordance with ASC 805-30-55-9A. See ASC 805-30-55-25 through ASC 805-30-55-35 for examples and additional information.
Figure BCG 3-2 illustrates how to calculate the amount of fair value attributed to precombination and postcombination vesting for an employee award.
Figure BCG 3-2
Calculation of amount of fair value attributed to precombination and postcombination vesting for an employee award

The total service period for employee awards includes both the requisite service period of the acquiree’s awards completed before the acquisition date and the postcombination requisite service period, if any, of the replacement awards in accordance with ASC 805-30-55-8 through ASC 805-30-55-9.
The amount attributable to precombination vesting should be included in the consideration transferred for the acquiree. The amount attributable to postcombination vesting, however, is not part of the consideration transferred for the acquired business. The amount attributable to postcombination vesting should instead be recognized as compensation cost in the postcombination financial statements over the postcombination requisite vesting period in accordance with ASC 805-30-30-12 through ASC 805-30-30-13 and ASC 805-30-55-10.
The method of attributing the fair value of replacement awards between periods of precombination vesting and postcombination vesting is the same for equity- and liability-classified awards. All changes in the fair-value-based measure of awards classified as liabilities (both the portions attributed to precombination service as well as postcombination service in the initial acquisition accounting) after the acquisition date and the related income tax effects are recognized as an expense in the acquirer’s postcombination financial statements in the periods in which the changes occur in accordance with ASC 805-30-55-13.
Question BCG 3-1 illustrates how fair value should be attributed to postcombination vesting for employee share options that are deep out of the money at the acquisition date.
Question BCG 3-1
How should fair value be attributed to postcombination vesting for employee share options that are deep out of the money at the acquisition date?
PwC response
For employees, deep out of the money options (i.e., the exercise price is significantly higher than the measurement date share price) may have a derived service period if retention of the awards by the employee is contingent upon employment (e.g., the contractual term of the awards will be truncated upon termination). The awards have a derived service period because the employee may effectively be required to provide service for some period of time to obtain any value from the award. Because the awards have a derived service period after the acquisition date, a portion of the replacement awards would be attributed to postcombination vesting and recognized as compensation cost in the postcombination financial statements in accordance with ASC 805-30-55-8 through ASC 805-30-55-9. See SC 2.6.2 for additional information.
For example, assume that, as of the acquisition date, employees of the acquiree are granted replacement awards with the same terms as their original awards. Under the terms of the awards, one year of service is required after the acquisition date for the awards to fully vest (i.e., the awards have an explicit service period of one year) and vested awards are forfeited upon termination of employment. However, on the acquisition date, the awards are deep out of the money. It is determined through the use of a lattice pricing model that the employee would need to provide three years of service to obtain any value from this award based on an expected increase in the company’s share price. This three-year service period is considered a derived service period under ASC 718-10-55-71. The postcombination vesting period should be based on the longer of the explicit service period or the derived service period. Therefore, in this example, the acquirer would use a derived service period of three years as opposed to the explicit service period of one year. The derived service period should generally be determined using a lattice model. Assessing whether an option is deep out of the money will require judgment and may be impacted by whether the derived service period is substantive. The length of the derived service period will be significantly affected by the volatility of the acquirer’s shares (i.e., all else equal, a higher volatility means a shorter derived vesting period). Note that this guidance on derived service periods is only applicable to employee awards, not nonemployee awards.
Question BCG 3-2 illustrates how the fair value of the acquirer’s unvested replacement awards included in the consideration transferred for the acquiree should reflect an estimate of forfeitures.
Question BCG 3-2
How should the fair value of the acquirer’s unvested replacement awards included in the consideration transferred for the acquiree reflect an estimate of forfeitures?
PwC response
Replacement share-based payment awards should be measured using the fair value-based measurement method in ASC 718. Under ASC 718-10-30-11, no compensation cost is recognized for an award that is not expected to vest. Accordingly, the amount included in consideration transferred for the acquiree related to unvested awards should be reduced to reflect an estimate of future forfeitures. An example is included within ASC 805-30-55-11.

Excerpt ASC 805-30-55-11

…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.

The estimate of future forfeitures should be based on the acquirer’s estimate of pre-vesting forfeitures, regardless of the acquirer’s accounting policy for forfeitures under ASC 718-10-35-3 (see SC 2.7.1). When determining this estimate, the acquirer may need to consider the acquiree’s historical employee data as well as the potential impact of the business combination on the employees’ future behavior in accordance with ASC 718-10-35-3 and ASC 805-30-55-11 through ASC 805-30-55-12. Any postcombination changes in assumptions should be recognized directly in net income.
Question BCG 3-3 illustrates how compensation cost recognized in the acquirer’s postcombination financial statements should be adjusted to reflect estimated forfeitures of unvested awards.
Question BCG 3-3
How should the compensation cost recognized in the acquirer’s postcombination financial statements be adjusted to reflect estimated forfeitures of unvested awards?
PwC response
Regardless of the accounting policy elected by the acquirer for forfeitures under ASC 718-10-35-3, in the event of an acquisition, an estimate of forfeitures is required under ASC 805-30-55-11. The amount of compensation cost attributed to precombination service (and included in consideration transferred in the acquisition) should be reduced to reflect estimated forfeitures. If an acquirer’s accounting policy is to estimate forfeitures, changes in the estimated forfeiture rate postcombination should be accounted for as adjustments to compensation cost in the period in which the change in estimate occurs in accordance with ASC 805-30-55-11. If an acquirer’s accounting policy is to account for forfeitures as they occur, the amount excluded from consideration transferred (because the requisite service is not expected to be rendered) should be attributed to the postcombination vesting and recognized in compensation cost over the requisite vesting period, also in accordance with ASC 805-30-55-11.

Example BCG 3-7 illustrates the difference in the postcombination accounting treatment based on the acquirer’s accounting policy election for forfeitures.
EXAMPLE BCG 3-7
Accounting treatment based on the acquirer’s accounting policy election for forfeitures
As part of Company A’s acquisition of Company B in a business combination, Company A is obligated to grant replacement awards to Company B’s employees. One year of postcombination service is required by Company B employees for the replacement awards to vest. Prior to the business combination, Company B’s employees completed three of the four years of the requisite service period. On the acquisition date, the fair value of the replacement awards is $100; however, Company A estimates that 20% of the awards will be forfeited before the end of the requisite service period.
How should Company A account for the awards if the company makes an accounting policy election to estimate forfeitures? Alternatively, how should Company A account for the awards if the company’s accounting policy election is to account for forfeitures when they occur?
Analysis
Regardless of Company A’s accounting policy election for forfeitures, an estimate of forfeitures is required to determine the consideration transferred in acquisition accounting. The amount included in the consideration transferred is calculated as follows: $100 fair value of Company A’s replacement awards multiplied by the percentage of the requisite service period completed (three of the four years = 75%), multiplied by the percentage of awards expected to vest (100% – 20% forfeiture rate = 80%) = $100 x 75% x 80% = $60.
Accounting policy election: estimate forfeitures
If Company A has an accounting policy that estimates forfeitures, the postcombination accounting compensation cost would be calculated as follows: $100 fair value of Company A’s replacement awards multiplied by the percentage of awards expected to vest (100% – 20% forfeiture rate = 80%), less the $60 included in the considered transferred = $100 x 80% - $60 = $20. This amount would be recorded as postcombination compensation cost and recognized over the one year of postcombination vesting required of Company B employees. Any change in the estimated forfeiture rate would be accounted for as an adjustment to compensation cost in the period in which the change in estimate occurs.
Accounting policy election: account for forfeitures when they occur
If Company A’s accounting policy is not to estimate forfeitures, it will account for them in the postcombination period as they occur as follows: $100 fair value of Company A’s replacement awards less the $60 included in the consideration transferred = $100 - $60 = $40. This amount would be recorded as postcombination compensation cost and recognized over the one year of postcombination vesting required of Company B employees. As forfeitures occur, compensation cost would be reduced.
Note: Under both of these elections, the guidance is not specific as to the subsequent treatment of Company A’s actual forfeitures (e.g., an increase in forfeitures resulting in a decrease in the number of awards expected to vest/awards that actually vest) that are reflected in the company’s postcombination compensation cost. Accordingly, we believe Company A should make one of the following accounting policy elections and apply it consistently: (1) reverse only compensation cost that was attributed to postcombination vesting and actually recognized as compensation cost by the acquirer; or (2) reverse all compensation cost for awards that do not actually vest, regardless of whether that measure was attributed to precombination or postcombination vesting as of the acquisition date. This amount may exceed the amounts previously recognized as compensation cost in the acquirer’s postcombination financial statements.

3.4.1.1 Awards with graded vesting features (business combinations)

Awards with graded vesting features vest in stages (tranches) over an award’s contractual term, as opposed to vesting on a specific date. An example of an award with graded-vesting features is an award that vests 25% each year over a four-year period. The portion of the award that vests each year is often referred to as a “vesting tranche.” See further discussion of the accounting for such awards in SC 2.8.
ASC 805-30-55-12 requires the attribution of compensation cost for the acquirer’s replacement awards in the postcombination financial statements to be based on the acquirer’s attribution policy (i.e., straight-line approach or graded-vesting approach for awards subject only to a service condition; the graded-vesting approach is required for awards that include performance or market conditions). The acquiree’s historical attribution policy is not relevant to the acquirer’s accounting. If the acquirer has a different accounting policy for the treatment of service-based awards with graded vesting features than the acquiree, this may result in amounts of compensation cost not being recognized either by the acquirer in the postcombination financial statements or the acquiree in its precombination financial statements. Alternatively, this may result in amounts of compensation expense being recognized by both the acquirer and acquiree in the postcombination and precombination financial statements, respectively.
The acquirer’s attribution policy should be applied consistently for all awards with similar features in accordance with ASC 805-30-55-12. If the acquirer does not have an existing policy for awards with graded vesting features, the acquirer should elect its own attribution policy (i.e., the acquirer is not required to adopt the accounting policy used by the acquiree).
Under the straight-line approach, a company recognizes compensation cost on a straight-line basis over the total service period for the entire award (i.e., over the service period of the last separately vesting tranche of the award), as long as the cumulative amount of compensation cost that is recognized on any date is at least equal to the grant-date fair value of the vested portion of the award on that date. Under the graded-vesting approach, a company recognizes compensation cost over the service period for each separately vesting tranche of the award as though the award is, in substance, multiple awards in accordance with ASC 718-10-35-8 and ASC 718-20-55-25 through ASC 718-20-55-34.
Question BCG 3-4 illustrates how an acquirer’s attribution policy impacts the amount attributable to precombination vesting for awards with graded vesting features.
Question BCG 3-4
How does an acquirer’s attribution policy impact the amount attributable to precombination vesting for awards with graded-vesting features?
PwC response
For awards with graded-vesting features, the amount of fair value of the replacement award attributable to precombination vesting should be determined based on the acquirer’s attribution policy for any of its existing awards in accordance with ASC 718-10-35-8. For example, assume an acquirer exchanges replacement awards with a fair value of $100 for the acquiree’s awards with a fair value of $100 (measured at the acquisition date) and there are no estimated forfeitures. Under their original terms, the replacement awards vest 25% each year over four years, based on continued service. At the acquisition date, one year of service has been rendered. The replacement awards have the same vesting period as the original acquiree awards; therefore, three additional years of service are required after the acquisition date for all of the awards to vest. The fair value attributable to precombination vesting will depend on the acquirer’s attribution policy as follows:
  • Straight-line attribution approach: If the acquirer’s attribution policy is the straight-line approach, the amount attributable to precombination vesting is $25 ($100 × 1/4 years).
  • Graded-vesting attribution approach: If the acquirer’s attribution policy is the graded-vesting approach, the amount attributable to precombination vesting is $52. The calculation of this amount (assuming the fair value of the award was estimated for the entire grant) is illustrated below:
Total fair value
% Vesting in year 1
Graded-vesting attributed in year 1
Tranche 1
$25
100%
$25.00
Tranche 2
25
50%
12.50
Tranche 3
25
33%
8.33
Tranche 4
25
25%
    6.25
Total
$100
$52.08
View table
Accordingly, if the acquirer’s attribution policy is the straight-line approach, $25 should be included in consideration transferred for the acquiree, and $75 ($100 less $25) should be recognized in the postcombination financial statements. If the acquirer’s attribution policy is the graded-vesting approach, $52 should be included in consideration transferred for the acquiree, and $48 ($100 less $52) should be recognized in the postcombination financial statements.

When acquiree share-based awards with graded-vesting features are granted prior to a business combination, some of the original awards may have vested and been exercised prior to the acquisition. Share-based payment awards of the acquiree that have already been exercised will be included in the consideration transferred for the acquiree’s outstanding shares. For replacement awards related to awards still outstanding at the time of the business combination, the acquirer must determine the portion of the awards’ fair value attributable to precombination vesting that will be recorded as part of the consideration transferred. The remainder of the fair value of the replacement awards will be attributable to postcombination vesting.
Example BCG 3-8 illustrates the attribution of the fair value of replacement awards to the precombination and postcombination vesting when a portion of the original awards has been exercised prior to the acquisition date.
EXAMPLE BCG 3-8
Attribution of the fair value of replacement awards with graded-vesting features to precombination and postcombination vesting as part of a business combination when a portion of the original awards has been exercised
Company A acquires Company B on July 1, 20X3. Company A issues replacement awards with identical terms for Company B’s outstanding awards held by grantees. The original awards were issued to grantees by Company B on January 1, 20X1 and provided grantees with the right to purchase 100 shares of Company B. The original awards vest annually over 5 years (i.e., the original awards vest at a rate of 20% per year on the anniversary of the date of grant). The first two tranches of the original awards were exercised prior to the acquisition and only the unvested tranches remain outstanding at the acquisition date. Company A’s accounting policy for recognizing compensation cost for share-based awards is the straight-line approach under US GAAP. The fair value of an award to purchase one common share at the acquisition date is $10. There is no excess fair value of the replacement awards over the fair value of the acquiree awards as of the acquisition date.
How should the fair value of the replacement awards be attributed to the precombination and postcombination vesting?
Analysis
The first two tranches of the original awards were exercised and are no longer outstanding. Therefore, the shares issued upon exercise of those awards would have already been included in the consideration transferred for Company B’s outstanding shares. Company A will issue replacement awards for the 60 share-based awards outstanding at the acquisition date. The fair value of the 60 replacement awards is $600 and Company A must determine the total amount attributable to precombination vesting that will be recorded as part of the consideration transferred for Company B. The remainder will be attributable to postcombination vesting.
One approach to attribute the fair value of the replacement awards to precombination and postcombination vesting would be to consider the initial awards to purchase 100 shares of Company B as if none of the awards had been exercised. In this case, the fair value as if all 100 of Company B’s awards were outstanding on the acquisition date (i.e., as a single unit) would be $1,000 (100 awards multiplied by $10 fair value). The awards would have been 50% vested as 2.5 years have elapsed as of the acquisition date out of the 5-year total vesting period. The 50% vesting would include the 40 share-based awards that have been exercised as well as the portion of the 20 replacement awards in the third tranche, which are half-way through the vesting period of January 1, 20X3 to January 1, 20X4. Multiplying the 50% vesting percentage to the awards’ entire fair value of $1,000 results in $500 attributable to precombination vesting (consideration transferred for Company B) if all 100 awards were outstanding and being replaced. However, since 40 of the awards with a hypothetical fair value of $400 have already vested and been exercised (and therefore included as part of consideration transferred for outstanding shares), only $100 of the $500 attributable to precombination vesting is recorded for the replacement awards as part of the consideration transferred for Company B. The aggregate unvested portion (50% or $500) of the entire awards’ fair value of $1,000 would be attributable to postcombination vesting. Or, said another way, subtracting the $100 attributable to precombination vesting from the $600 fair value of the 60 replacement awards results in $500 attributable to postcombination vesting.
Another approach to attribute the fair value of the replacement awards to precombination and postcombination vesting may be to determine the hypothetical vesting inception date for the remaining outstanding awards, as the straight-line method inherently views each tranche as a series of awards with sequential vesting periods. In this fact pattern, the hypothetical vesting-inception date would be January 1, 20X3, coincident with the beginning of the vesting period of the third tranche, and the vesting period would end on January 1, 20X6, the final vesting date of the fifth tranche of the original award. The 60 remaining outstanding awards are therefore 16.7% vested as 6 months have elapsed (January 1, 20X3 to the acquisition date of July 1, 20X3) out of the 3-year vesting period from the hypothetical vesting-inception date until the final vesting date of the original award. Multiplying the $600 fair value of the 60 replacement awards exchanged as of the acquisition date by 16.7% results in $100 to be attributed to precombination vesting (consideration transferred for Company B). The remaining $500 ($600 - $100) would be attributable to postcombination vesting.
Additional analyses may be necessary to attribute the fair value of the replacement awards to precombination and postcombination vesting in more complex fact patterns. Complex fact patterns may include situations where tranches are only partially exercised, awards do not vest ratably, or complete records are not available to specifically identify the tranche of exercised awards.
If Company A’s accounting policy for recognizing share-based award compensation cost were to utilize a graded-vesting allocation approach, the allocation would be calculated differently. Under a graded-vesting allocation approach $392 of the $600 fair value of the replacement awards would be attributable to precombination vesting and be recorded as part of the consideration transferred for Company B. This is calculated as follows:
Replacement awards
Total fair value
% Vesting at acquisition date
Graded-vesting attributed to precombination vesting
Tranche 3
$200
83.3% 1
$167
Tranche 4
200
62.5% 2
125
Tranche 5
         200
50.0% 3
         100
$600
$392
View table
______________
1 Calculated as 30 months out of 36 months total service period.
2 Calculated as 30 months out of 48 months total service period.
3 Calculated as 30 months out of 60 months total service period.
The remaining value of the 60 replacement awards is attributable to postcombination vesting. That is, $600 fair value of the 60 replacement awards less the $392 attributable to precombination vesting results in $208 attributable to postcombination vesting.

3.4.2 Additional service required postcombination

A grantee may hold an award that is fully vested under its original terms, but the terms of the replacement award require additional service from the grantee. Although the holder of the award performed all of the service as required by the original award granted by the acquiree, the acquirer added an additional service period to the replacement awards. Therefore, a portion of the fair value of the replacement award will be attributable to postcombination vesting.
Consider a scenario in which the original terms of an award require four years of service which were completed as of the acquisition date. However, an additional year of service was added to the terms of the replacement award by the acquirer, resulting in a total service period of five years. The acquirer will use the ratio of the four years of service completed compared to the total service period of five years (the greater of the original service period or the total service period required by the replacement award, as described in BCG 3.4.1), resulting in 80% of the fair value of the acquiree award being attributed to precombination vesting and accounted for as consideration transferred for the acquiree. The remaining fair value of the replacement award, including any excess fair value, would be accounted for over the remaining service period of one year in the postcombination financial statements.

3.4.3 Less service required postcombination

A replacement award that requires less service after the acquisition than would have been required under the original award effectively accelerates the vesting of the original award, eliminating all or a portion of the postcombination vesting requirement. See BCG 3.4.3.1 for information on awards with an automatic change in control clause. The amount of fair value attributable to the accelerated vesting of the award should be recognized as additional compensation cost separate from the business combination. The amount included in the consideration transferred for the acquiree is limited to the amount of the acquiree’s award attributable to precombination vesting. The ratio of the precombination service period to the greater of the total service period or the original service period of the acquiree award should be used when calculating the amount of the replacement award attributable to precombination vesting.
Example BCG 3-9 further illustrates this guidance when the service required after the acquisition date is less than the original requirement.
EXAMPLE BCG 3-9
Attribution of fair value when service required after the acquisition date is less than the original vesting requirement
Company X (the acquirer) exchanges replacement awards with a fair value of $100 for Company Y’s (the acquiree) awards with a fair value of $100. When originally granted, Company Y’s awards provided for cliff vesting after a service period of four years from the grant date. As of the acquisition date, three of the four years of service required by the original terms of Company Y’s awards have been rendered. The replacement awards issued by Company X are fully vested. Company X was obligated to issue replacement awards under the terms of the acquisition agreement.
How should the fair value of the replacement awards be attributed to the precombination vesting?
Analysis
Company X effectively accelerated the vesting of the awards by eliminating the one year of postcombination vesting that would have been required under the awards’ original terms. The amount of Company X’s replacement awards’ value attributable to precombination vesting is equal to the fair value of Company Y’s awards at the acquisition date, multiplied by the ratio of precombination service period to the greater of the total service period or the original service period of Company Y’s awards.
  • The total service period is three years (i.e., the years of service rendered as of the acquisition date).
  • The original service period of Company Y’s awards was four years.
  • The original service period of four years is greater than the total service period of three years; therefore, the original service period of four years should be used to determine the amount attributable to precombination vesting; the amount attributable to precombination vesting is $75 (the value of Company Y’s awards of $100 × 3 years precombination vesting / 4 years original vesting).
  • The fair value of Company Y’s replacement awards of $100, less the amount attributed to precombination vesting of $75, or $25 (the portion for which vesting was accelerated), should be recognized in the postcombination financial statements. Because the replacement awards are fully vested, the entire $25 should be recognized immediately in the postcombination financial statements.


3.4.3.1 Automatic change in control provision in business combinations

The fair value of acquiree awards that include a preexisting, automatic change in control clause (whereby awards vest immediately upon a change in control) should be included in the consideration transferred for the acquiree. The excess fair value of any replacement awards over the fair value of the acquiree awards should be reflected as compensation cost in the postcombination period in accordance with ASC 805-30-55-18 through ASC 805-30-55-19.
Example BCG 3-10 illustrates the accounting for an award with an automatic change in control provision.
EXAMPLE BCG 3-10
Allocation of fair value when an automatic change in control provision accelerates vesting upon closing of an acquisition
Company X (the acquirer) exchanges vested shares with a fair value of $100 for Company Y’s (the acquiree) awards with a fair value of $100. Company Y’s awards contain a change in control clause, whereby they automatically vest upon closing of an acquisition. When originally granted, Company Y’s awards provide for cliff vesting after a service period of four years. As of the acquisition date, three of the four years of service required by the original terms of Company Y’s awards have been rendered.
How should the fair value of the replacement awards be attributed to the precombination vesting?
Analysis
The change in control clause in Company Y’s awards requires that all awards automatically vest upon closing of an acquisition. Due to the fact that the change in control clause was in the original terms of Company Y’s awards prior to the acquisition and required automatic vesting of the awards, there is no need to compare the total service period to the original service period. Therefore, the amount attributable to precombination vesting is the entire $100 fair value of the original Company Y awards (which is also the value of the replacement awards, so there is no amount to include in postcombination cost). If the replacement awards issued by Company X had a fair value greater than $100, any excess would have been recognized immediately in the postcombination financial statements of the combined company.

However, in certain circumstances, what appears to be a preexisting change in control clause may have recently been added to the acquiree’s awards in conjunction with the negotiation of the business combination. In this situation, the guidance in ASC 805-10-55-18 should be considered (see BCG 3.2) to determine if the change benefits the acquirer and should be accounted for separate from the business combination. If so, the determination of the portion of the fair value of the replacement award that is attributed to precombination service should exclude the effect of the acceleration feature. Therefore, the impact of the acceleration will be reflected in postcombination compensation cost, similar to the analysis in Example BCG 3-9. Accordingly, such features should be carefully assessed.

3.4.3.2 Discretionary change in control provision (business combinations)

Acquiree awards for which vesting is accelerated based on a discretionary change in control clause need to be analyzed to determine if the acceleration of the vesting of the awards by the acquiree was arranged primarily for the economic benefit of the acquirer (or combined entity), or if it was for the benefit of the acquiree. The portion of the fair value of the acquiree’s award related to the acceleration of vesting under a discretionary change in control clause would be recognized in the postcombination financial statements of the combined company if it is for the benefit of the acquirer (as illustrated in Example BCG 3-9). Refer to BCG 3.2 for the factors to consider in this analysis.

3.4.4 Excess fair value of replacement awards (business combinations)

Any excess fair value of the replacement awards over the fair value of the acquiree awards at the acquisition date is considered compensation cost incurred by the acquirer outside of the business combination. The excess fair value at the acquisition date, typically, is not significant if the replacement awards have the same terms and conditions as the acquiree awards. The assumptions used to calculate fair value immediately before the business combination may converge with the assumptions used to calculate the fair value of the replacement awards immediately after the modification because the value of the equity of the acquirer and the acquiree will usually reflect the pending acquisition as the closing date approaches.
However, if the acquirer changes the terms and conditions of the awards or the grantees’ awards are exchanged using a different ratio than that offered to other equity holders (as this would usually be a change to make the awards more valuable to the grantees), it is likely that there will be excess fair value. The acquirer should recognize the excess fair value over the remaining vesting period in the postcombination financial statements in accordance with ASC 805-30-55-10. Refer to ASC 805-30-55-18 through ASC 805-30-55-19 for an example of replacement awards with excess fair value.

3.4.5 Acquiree awards that continue after the business combination

There may be circumstances when acquiree awards are not exchanged and do not expire but continue after the business combination as rights to acquire noncontrolling interests. This may occur when the acquirer purchases a target company and the target company continues as a separate subsidiary of the acquirer. When the awards of the target are not exchanged but continue under the original terms after the business combination (see Figure BCG 3-1, scenario 3), we believe the acquirer could account for the continuation of the awards as if the acquirer was obligated to issue replacement awards. This is similar to an exchange of awards in a business combination under ASC 805-30-30. Alternatively, the acquirer could choose to account for the awards separate from the business combination. The acquirer would account for the awards as new grants and recognize the fair value of the awards as compensation cost in the postcombination period.
Under either approach, as the awards vest over time, the acquirer would recognize compensation cost for the share-based payment awards, with a corresponding credit to noncontrolling interests. See BCG 5.4.2 for further information.

3.4.6 Awards with performance/market conditions (business combinations)

For awards with performance conditions (as defined by ASC 718), the acquirer should follow the same principle used for awards with service conditions. That is, the fair value of the original awards should be allocated between precombination and postcombination vesting, and the amount by which the fair value of the replacement awards exceeds the fair value of the original awards should be recognized in the postcombination financial statements in accordance with ASC 805-30-55-10.
However, the amount attributable to precombination vesting should incorporate the acquirer’s assessment of the probability of achieving the performance condition as of the acquisition date. The amount attributable to precombination vesting is determined by multiplying the fair value of the acquiree awards that are probable of vesting as of the acquisition date by the appropriate ratio of the precombination vesting period completed prior to the exchange to the total vesting period, as described in BCG 3.4.1. The amount attributable to postcombination vesting would then be calculated by subtracting the portion attributable to precombination vesting from the total fair value of the acquirer’s replacement award. The determination of the postcombination vesting period for the replacement awards should include consideration of the performance condition and the period in which it is probable that the performance condition will be achieved. For awards with market conditions, the impact of the condition is incorporated into the determination of the fair value of the award, regardless of probability.
Example BCG 3-11 and Question BCG 3-5 illustrate application of this guidance to awards with a performance condition.
EXAMPLE BCG 3-11
Allocation of fair value for awards with a performance condition
Company Z (the acquirer) exchanges replacement awards with a fair value of $300 for Company A’s (the acquiree) employee awards with a fair value of $300. Company Z was obligated to issue replacement awards under the terms of the acquisition agreement. When granted, Company A’s awards cliff vest following the completion of the development of a new product. Because the awards contain a performance condition, at the acquisition date Company Z should assess the probability of whether the performance condition will be achieved. Prior to the acquisition, Company A considered it probable that the product would be finished three years from the grant date. As of the acquisition date, one year has passed since the grant date; therefore, two years remain in the original requisite service period. Company Z assessed the performance condition on the acquisition date and determined that it is still likely that the new product will be completed two years from the acquisition date. This probability assessment should be consistent with the assumptions included in the valuation of Company A’s in-process research and development (IPR&D).
How much of the fair value of the replacement awards should be attributed to precombination vesting?
Analysis
The amount of Company Z’s replacement awards attributable to precombination vesting is equal to the fair value of Company A’s awards at the acquisition date that are considered probable of vesting, multiplied by the ratio of the precombination service period to the greater of the total requisite service period or the original requisite service period of Company A’s awards. The original requisite service period of Company A’s awards was three years. At the acquisition date, Company Z determined that it is still probable that the development of the new product will be completed in two more years; therefore, the awards will have a total requisite service period of three years. That is, the original requisite service period and the total requisite service period are both three years. The amount attributable to precombination vesting is $100 ($300 × 1 year precombination service / 3 years original service). The remaining fair value of the awards of $200 should be recognized in the postcombination financial statements over the remaining service period of two years because the awards have not yet vested.
Had the acquirer determined on the acquisition date that it was probable that the product would be completed one year from the acquisition date, then the amount attributable to precombination vesting ($100) would remain the same. This would be the case since the original requisite service period of three years is greater than the total requisite service period of two years. The remaining fair value of $200, however, would be recognized over the remaining service period of one year.

Question BCG 3-5
How should the acquirer account for the exchange of an equity settled award with a performance (nonmarket) condition (as defined by ASC 718), assuming it is not probable both before and after the exchange that the condition will be achieved?
PwC response
Under ASC 718, the probability that an award with a service or performance condition will vest is not incorporated into the fair value of the award; instead, compensation cost is recognized only for awards expected to vest. In other words, compensation cost is recognized if and when it is probable that the performance condition will be achieved, in accordance with ASC 718-10-35-3.
Replacement share-based payment awards should be measured using the fair-value-based measurement method of ASC 718 in accordance with ASC 805-30-30-11 and ASC 805-30-55-7. Under ASC 718-10-35-3, no compensation cost is recognized for an award with a performance condition that is not expected to vest. Accordingly, if it is not probable both before and after the exchange that the performance condition will be achieved, then no amount should be recorded for that replacement award in connection with the business combination for precombination services. The acquirer should not record any compensation cost in the postcombination financial statements until achievement of the performance condition becomes probable.
Once achievement of the performance condition becomes probable, the company should begin recognizing cumulative compensation cost from the date it becomes probable based on the fair value of the replacement award as of the acquisition date. No adjustment should be made to the amounts recorded in connection with the business combination (e.g., goodwill) in accordance with ASC 805-30-55-11 through ASC 805-30-55-12.

As described in SC 2.5.2, the impact of market conditions should be incorporated into the determination of the fair value of a share-based payment award. The determination of the fair value attributable to precombination and postcombination vesting for awards with a market condition is consistent with the analysis performed for awards with service conditions. The determination of the precombination and postcombination service periods for the replacement awards, as well as the fair value of the acquiree and acquirer awards, should include consideration of the market condition. As noted in BCG 3.4.4, the assumptions used to calculate fair value immediately before the business combination may converge with the assumptions used to calculate the fair value of the replacement awards immediately after the exchange.

3.4.7 Attribution of fair value to pre/postcombination vesting

The examples presented in Figure BCG 3-3 are based on the following assumptions: (1) the original terms of the acquiree’s employee awards cliff vest following four years of service, (2) the acquirer is obligated to issue replacement awards under the terms of the acquisition agreement (except as specified in Scenario 6), (3) the fair value of the replacement awards is equal to the fair value of the acquiree awards on the acquisition date (except as specified in Scenario 3), and (4) all of the replacement awards are expected to vest (i.e., there are no estimated forfeitures). See BCG 3.4.1.1 for information on awards with graded vesting features.
Figure BCG 3-3
Attribution of fair value to pre/postcombination vesting
Acquiree’s awards
Acquirer’s
replacement
awards
Greater of
total service
period or original
service period
Fair value attributable to
precombination
vesting
Fair value attributable to
postcombination
vesting
Scenario 1:
4 years of service required under original terms. All required services rendered prior to acquisition.
No service required after the acquisition date.
4 years. The original service period and the total vesting period are the same
100% (4 years precombination service/4 years total service).
0%
Scenario 2:
4 years of service required under original terms. 3 years of service rendered prior to acquisition.
1 year of service required after the acquisition date.
4 years (3 years prior to acquisition plus 1 year after acquisition). The original service period and the total service period are the same
75% (3 years precombination service/4 years total service).
25% (total fair value of the replacement award less the 75% for precombination vesting). This amount is recognized in the postcombination financial statements over the remaining service period of 1 year.
Scenario 3:
4 years of service required under original terms. 4 years of service rendered prior to acquisition.
1 year of service required after the acquisition date. The grantee has agreed to the additional year of service because the fair value of the replacement awards is greater than the fair value of the acquiree awards.
5 years (4 years completed prior to acquisition plus 1 year required after acquisition). The total service period of 5 years is greater than the original service period of 4 years.
80% of the acquiree award (4 years precombination service/5 years total service).
20% of the acquiree award and the excess fair value of the replacement award (total fair value of the replacement award less the 80% for precombination vesting). This amount is recognized in the postcombination financial statements over the remaining service period of 1 year.
Scenario 4:
4 years of service required under original terms. 1 year of service rendered prior to acquisition.
2 years of service required after the acquisition date. Therefore, the replacement awards require one less year of service.
4 years (since only 2 years of service are required postcombination, the total service period for the replacement awards is 3 years, which is less than the original service period of 4 years). Therefore, the original service period is greater than the total service period.
25% (1 year precombination service/4 years original service period).
75% (total fair value of the replacement award less the 25% for precombination vesting). This amount is recognized in the postcombination financial statements over the remaining service period of 2 years.
Scenario 5:
4 years of service required under original terms. 3 years of service rendered prior to acquisition. There was no change in control clause in the terms of the acquiree awards.
No service required after the acquisition date.
4 years (since no additional service is required, the total service period for the replacement awards is 3 years, which is less than the original service period of 4 years). Therefore, the original service period is greater than the total service period.
75% (3 years precombination service / 4 years original service period).
25% (total fair value of the replacement award less the 75% for precombination vesting). This amount is recognized in the postcombination financial statements immediately because no future service is required.
Scenario 6:
4 years of service required under original terms. 3 years of service rendered prior to acquisition. There was a change in control clause in the original terms of the acquiree awards when granted that accelerated vesting upon a change in control.
No service required after the acquisition date.
Not applicable. Because the awards contain a pre-existing change in control clause, the total fair value of the acquiree awards is attributable to precombination vesting.
100%. For acquiree awards with a change in control clause that accelerates vesting, the total fair value of the acquiree awards is attributable to precombination vesting.
0%. For acquiree awards with a pre-existing change in control clause, no amount is attributable to postcombination vesting because there is no future service required.
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