As Figure SC 2-8 describes, a company may change its initial estimate of requisite service period in certain circumstances. However, not all such changes are treated the same:
- If either the quantity or grant-date fair value of an award changes because another performance or service condition becomes probable of satisfaction (e.g., the performance condition affects exercise price), that change will be accounted for as a “cumulative effect” (for the portion of the requisite service period that has been rendered) on both current and prior periods in the period of the change.
- If an initially estimated requisite service 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 will be recognized prospectively over the revised requisite service period, if any (i.e., no “cumulative effect” adjustment recognized).
Example SC 2-12, Example SC 2-13 and Example SC 2-14 illustrate how a company should consider necessary adjustments to the requisite service period over the life of the award, based on the type of vesting condition.
EXAMPLE SC 2-12
Changes to the requisite service period for an award with service and performance conditions
On January 1, 20X1, SC Corporation grants two executives a total of 100,000 stock options. The grant-date fair value is $10 per option. The terms of the award specify that the award will vest if both of the following conditions are satisfied: (1) the completion of a new product design (i.e., a performance condition) and (2) the executive is employed on the date the new product design is completed (i.e., a service condition). At the grant date, SC Corporation determines that it is probable that the new product design will be completed two years from the grant date. SC Corporation also believes the executives will be employed on that date.
What is the appropriate requisite service period?
When determining the requisite service period, SC Corporation must assess the probability that the performance condition will be satisfied. As it is probable both of the conditions will be met, the requisite service period would be two years. SC Corporation would recognize $500,000 ($10 fair value × 100,000 options = $1,000,000 ÷ 2-year service period) of compensation cost each year.
Because the award has a performance condition, SC Corporation must reassess the probability of satisfaction of the performance condition each reporting period. If a year after the grant date, SC Corporation determines that it is now probable that the performance condition will be satisfied in three years (i.e., two years from the current date and one year longer than originally estimated), SC Corporation must adjust its accounting for the awards.
Assuming it is probable that the executives will employed for the next two years, the remaining requisite service period would be two years, as compared to the one year remaining requisite service period based on SC Corporation’s original estimate.
The change in the requisite service period affects only the attribution of expense. The fair value of the award is not remeasured. Therefore, SC Corporation should account for the change in estimated requisite service period prospectively. SC Corporation should record the remaining unrecognized compensation cost of $500,000 over the remaining two years of the updated requisite service period ($250,000 each year).
EXAMPLE SC 2-13
Changes to the requisite service period for an award with service and market conditions
On January 1, 20X1, SC Corporation grants two executives a total of 100,000 stock options. The terms of the award specify that the award will vest upon the earlier of (a) the stock price reaching and staying at a minimum of $100 per share for 60 consecutive trading days (i.e., a market condition) or (b) the completion of five years of service (i.e., a service condition).
What is the appropriate requisite service period?
Because the award has a market condition, the company uses a lattice model to estimate the award’s fair value and determine if the derived service period is shorter than the explicit service condition. The company derives its estimate of the award’s service period from the lattice model’s results, which in this case is three years. Therefore, the requisite service period over which compensation cost should be attributed is the market condition’s derived service period of three years (rather than the five-year service period) because it is the shorter requisite service period.
Because the award has a market condition, the requisite service period is not revised unless the market condition is satisfied before the end of the derived service period. If the market condition is satisfied in only two (not three) years, the company should immediately recognize any unrecognized compensation cost, because the executives do not have to provide any further service to earn the award. Alternatively, if the market condition is not satisfied but the executives render the three years of requisite service, compensation cost should not be reversed.
EXAMPLE SC 2-14
Changes to the requisite service period for an award with a vesting acceleration clause
On January 1, 20X1, SC Corporation grants an executive 40,000 stock options. The grant-date fair value is $10 per option. The terms of the award specify that the award will cliff vest if the executive is employed at the end of a four-year service period. Vesting will also be accelerated if the executive is terminated by the company without cause. At the grant date, it is probable that the four-year service condition will be achieved. However, at the beginning of 20X2, SC Corporation determines that it will terminate the executive without cause by June 30, 20X2.
What is the appropriate requisite service period? What is the impact of the decision to terminate the executive?
The four-year vesting provision is a service condition. Additionally, as described in ASC 718-10-20, acceleration of vesting in the event of an employee’s death, disability, or termination without cause is also considered a service condition. Since there are two potential service conditions (only one of which needs to be satisfied), SC Corporation would evaluate the different conditions and determine which one(s) are probable of achievement, and then use the shortest of those periods as the initial requisite service period. As of the grant date, SC determined that it was probable that the four-year service condition would be achieved, and it was not probable that an involuntary termination would occur. Therefore, SC Corporation began to recognize the grant-date fair value over the initial four-year requisite service period.
As required by ASC 718-10-55-77
, SC Corporation should reassess the probability of the different vesting conditions and adjust its estimate of the requisite service period as those assessments change. When it becomes probable that SC Corporation intends to terminate the executive (which will trigger the automatic acceleration feature), the service condition associated with the termination without cause becomes probable of being satisfied. As the remaining period until this vesting date (estimated to be 6 months) is shorter than the remaining 3 years in the original four-year vesting period, the requisite service period should be changed to the shorter period. Consistent with ASC 718-10-55-78
and ASC 718-10-55-79
, SC Corporation would recognize any remaining unrecognized compensation cost for the award prospectively over the revised requisite service period (i.e., no “cumulative effect” adjustment is recognized). The fair value of the award is not remeasured. The change in the requisite service period affects only the attribution of expense going forward. Therefore, SC Corporation would record the remaining unrecognized compensation cost of $300,000 over the remaining 6-month estimated requisite service period.