ASC 710-10-25-12 through ASC 710-10-25-14 provides that all or a portion of a lump-sum payment made in connection with the signing of a new union contract may be deferred and amortized over a period not to extend beyond the contract period. This guidance is applicable only when it is clear that the payment will benefit a future period in the form of a lower base wage rate than otherwise would have existed. If the lump-sum payment does not benefit a future period, it is recognized as a one-time expense. This guidance relates solely to union contracts and not to individual employment contracts or any other situation involving compensation payments to individual employees. The SEC observer (see ASC 710-10-S99-1) noted that deferral of a lump-sum payment is appropriate only when there is no evidence whatsoever that the payment might be related to past services.

When a cash bonus contract provides benefits that cover a service period greater than one year, ASC 710-10-25-9 states that "…the cost of those benefits shall be accrued over that period of the employee’s service in a systematic and rational manner." It would not be appropriate, for example, to record all of the expense in one year if additional years of service are required to be rendered in order to earn that bonus, even if the amount is based on the initial year’s financial performance. In addition, the cumulative expense recognized should not be less than the expense associated with vested amounts, and, generally, should not result in back-loading of expense. Further, whatever method of attribution of cost is utilized should be consistently applied to similar contracts or plans.

ASC 710 does not address whether an entity should estimate forfeitures in cash plans or account for the forfeitures as they occur. However, given the ability to estimate forfeitures under ASC 718 and the fact that estimating forfeitures could be viewed as "systematic and rational" as contemplated by ASC 710, we believe that it would be acceptable to estimate forfeitures in a cash plan as long as management has the ability to make a reasonable estimate. For example, it may be difficult for a start-up enterprise with limited history to estimate forfeitures. A decision to estimate forfeitures in cash awards is an accounting policy election that should be consistently applied to similar arrangements.

Question PEB 6-2 illustrates the accounting for a cash bonus that vests on a graded basis.

Under ASC 710-10-25-9, the cost of benefits attributed to a period or service greater than one year should be accrued over the period of service in a systematic and rational manner. One such manner is the accelerated attribution approach sometimes applied to share-based awards (e.g., compensation cost in the first year of the award would be calculated as 100% of the year 1 tranche, 50% of the year 2 tranche and 33.3% of the year 3 tranche). Another approach is recognition of the entire value of the benefit on a straight-line basis (i.e., 33% per year). Selection of an approach would be an accounting policy election that should be applied to similar arrangements. Other methods of attribution that are systematic and rational may also be acceptable.

Cash bonus plans may also include performance or market conditions (see SC 2.5). Cash bonus plans that include performance conditions are subject to the guidance in ASC 710—i.e., the cost of those benefits should be accrued over the period of service when management determines that it is probable that the performance condition will be achieved. In this context, the meaning of probable is consistent with its definition in ASC 450. When the performance condition is not considered probable, no cost is accrued, or previously accrued cost is reversed. If a performance condition is initially considered not probable and the assessment of the probability changes, we believe there are two approaches to account for any adjustments made to the estimated incentive payout.

In the first approach, the reporting entity can increase the accrual to reflect the amount that cumulatively would have been accrued by the end of the reporting period had the performance condition been assessed as probable from the inception of the service period. The remaining balance, thereafter, should be accrued as future services are rendered. The second approach would be for the reporting entity to account for the increased compensation prospectively (i.e., accrue the total estimated compensation assessed as probable over the remaining period with no immediate adjustment to the accrual). Under this approach, the reporting entity would still need to ensure that the accrual recorded at the balance sheet date reflects at least the portion of the bonus in which participants have vested.

Plans that include a market condition that is based, at least in part, on the price of the entity's shares or other equity instruments should be accounted for in accordance with ASC 718. See SC, PwC's Stock-based compensation guide, regarding the accounting for awards subject to ASC 718.

Example PEB 6-1 illustrates the accounting for changes in the incentive payout due to reassessment of the probable outcome of the performance condition.

EXAMPLE PEB 6-1
Accounting for changes in the probability assessment of a performance condition

On June 30, 20X1, PEB Corporation set up a long-term incentive plan for certain of its key executives. PEB Corporation has a calendar year end. The plan has a performance condition based on achieving targeted net income levels calculated on a cumulative basis for the two-year period ending June 30, 20X3. Participants vest in the bonus on June 30, 20X3. The estimated payouts are based on reaching the targeted cumulative net income levels are as follows:

PEB Corporation is accounting for the long-term incentive plan by recognizing the anticipated payout using straight-line attribution over the 24-month vesting period. Bonuses under the incentive plan will be paid out in July 20X3, once results for the cumulative two-year performance period have been determined.

On June 30, 20X1, PEB Corporation anticipates that the cumulative net income will reach $27 million by June 30, 20X3 and, therefore, the payout will be $3 million. PEB Corporation accrues $375,000 in each of the third and fourth quarters of 20X3. Absent a change in facts and circumstance, PEB Corporation would accrue another $375,000 in the first quarter of 20X2 for a cumulative total of $1,125,000 as of March 31, 20X2.

On March 31, 20X2, when the performance measurements are reassessed, management estimates that cumulative net income will be at least $30 million and, therefore, the estimated payout is projected to be $5 million.

How should PEB Corporation account for the change in the probable incentive payout from $3 million to $5 million?

If PEB Corporation had estimated the probable payout to be $5,000,000 from inception of the plan, it would have accrued $1,250,000 in the second half of 20X1 ($625,000 per quarter for two quarters) and another $625,000 in 20X2 for a total accrual by March 31, 20X2 of $1,875,000.

Based on the updated assessment of the award at March 31, 20X2, PEB Corporation needs to increase its accrual. It has two options:

Example PEB 6-2 illustrates accounting for an additional cash bonus to be paid in a subsequent year.

EXAMPLE PEB 6-2
Accounting for a discretionary cash bonus to be paid in a subsequent year

PEB Corporation had a particularly good year in 20X0 and decides in early 20X1 to set aside an additional amount of bonus money for key executives. The bonuses will be paid out in January 20X2 and require continued employment through that date in order for the executives to be eligible to receive their bonus.

PEB Corporation has an existing annual bonus plan that allows the compensation committee discretion in increasing or decreasing the amount of the final bonus. Such amounts are determined and paid in late January of each year.

When should the amount of the additional bonus be accrued as an expense?

The additional bonus expense should be accrued over the period from February 20X1, when the plan is established, through January 20X2, when the amounts become payable to specific executives (i.e., the implied service period for the award). The rationale for this conclusion is as follows:

Example PEB 6-3 illustrates attribution of expense for a cash bonus funded using a trust.

EXAMPLE PEB 6-3
Attribution of expense for a cash bonus funded using a trust

PEB Corporation commits to fund a Retention Trust with $15 million for the purposes of an annual bonus payout. PEB Corporation will fund the trust in $5 million increments over the next three years. PEB Corporation will determine the amount of the bonus on an annual basis and that amount will be distributed to employees from the trust annually. The amount paid each year may be more or less than the annual $5 million in trust funding; however, PEB Corporation is required to distribute the entire $15 million by the end of the third year. This arrangement is communicated to employees who may participate in the bonus program.

How should compensation cost be attributed over the three-year period?

As PEB Corporation is required to distribute the total $15 million over the three years, regardless of the annual allocation to employees, recognition of compensation cost on a straight-line basis over the three-year period may be an appropriate approach.

PEB Corporation’s ability to pay out an amount greater or less than the current year trust contribution is not the predominant factor in the determination of the attribution method. However, if it is probable that PEB Corporation will pay out more than the amount of straight-line compensation expense cumulatively recognized, then PEB Corporation should adjust the amount recognized as compensation to equal the estimated bonus payment that is going to be made. The cumulative compensation expense recognized should not be less than the actual compensation cost paid. That is, delayed recognition of the compensation cost actually paid, with no clawback features, would not be appropriate.