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Under ASC 718, the fair value of stock-based compensation is recognized over the employee's requisite service period. This section discusses the determination of the grant date, service inception date, and requisite service period, expense attribution and how to account for changes in the requisite service period.

2.6.1 Grant date for stock-based compensation awards

The fair value of an award is measured on the grant date. For equity awards, the fair value is generally not remeasured unless there is a modification. For liability-classified awards, the fair value is remeasured each period until settlement. This difference is summarized in Figure SC 2-3. Refer to SC 3 for further discussion of liability-classified awards.
Figure SC 2-3
Balance Sheet classification
Award classification
Measurement effect
Liability
Variable—Remeasured at the end of each reporting period, at fair value, until settlement
Equity
Fixed—Measured at fair value on the grant date and not remeasured unless the award is modified
A grant date is established when the following criteria are met:
  • The employer and its employees have reached a mutual understanding of the award’s key terms and conditions.
  • The company is contingently obligated to issue shares or transfer assets to employees who fulfill vesting conditions.
  • An employee begins to benefit from, or be adversely affected by, subsequent changes in the employer’s stock price (e.g., the exercise price for an option is known at the grant date). However, this criterion would not apply if the award does not ultimately depend on subsequent changes in the stock price, such as fixed dollar awards settleable in a variable number of shares. See SC 3.3.2.3.
  • Awards are approved by the board of directors, management, or both if such approvals are required, unless perfunctory.
  • The recipient meets the definition of an employee (i.e., grant date cannot be established prior to first day of employment) if the award is for employee service.

Awards offered under a plan that is subject to shareholder approval are not considered granted until the approval is obtained, unless such approval is essentially a formality (or perfunctory). That is, if management and board members control enough votes to approve the plan, the vote may be considered perfunctory (i.e., approval may be automatically assumed).
In some situations, the board of directors approves a pool of awards and delegates authority to management to allocate the pool to individual employees. The awards are not considered “approved,” as required by the grant date criteria, until management approves the allocation of the pool to individual employees.
A mutual understanding of the key terms and conditions of an award exists at the date the award is approved by the board of directors or other management with relevant authority if the following conditions are met (ASC 718-10-25-5):
  • 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 employer.
  • 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.

ASC 718-10-25-5(b) provides that “a relatively short time period” should be determined based on the period during which an entity could reasonably complete the actions necessary to communicate the terms of an award to the recipients in accordance with the entity’s customary human resource practices. We believe that “a relatively short time period” should generally be measured in days or weeks, not months. Companies should consider their individual facts and circumstances to define a reasonable period of time for communicating to employees, which may be impacted by factors such as the method of communication (e.g., in person or via e-mail) and the number and geographical location of employees receiving awards.
Example SC 2-5, Example SC 2-6, and Example SC 2-7 illustrate the determination of the grant date. These examples do not address whether the service inception date might precede the grant date, as discussed in SC 2.6.4.
EXAMPLE SC 2-5
Determining grant date – stock options
On January 1, 20X1, SC Corporation approves a stock option award with a vesting period that begins on February 1, 20X1. All of the recipients are employees that are already providing service as of January 1, 20X1. All of the terms and conditions of the award are approved on January 1, 20X1 and communicated to the employees within a relatively short time period, except that the exercise price of the options will be equal to the market price of SC Corporation’s stock on February 1, 20X1.
What is the grant date of the award?
Analysis
The grant date is February 1, 20X1 because the exercise price of the options is not established until that date. As a result, the employees do not begin to benefit from, or be adversely affected by, subsequent changes in the employer’s stock price until February 1, 20X1.
EXAMPLE SC 2-6
Determining grant date – restricted stock
On January 1, 20X1, SC Corporation approves a restricted stock award with a vesting period that begins on February 1, 20X1. The board of director’s approval states that the award is “granted” as of February 1, 20X1. All of the recipients are employees that are already providing service as of January 1, 20X1. All of the terms and conditions of the award are approved on January 1, 20X1 and communicated to the employees within a relatively short time period.
What is the grant date of the award?
Analysis
The grant date is likely January 1, 20X1. Even though the board of director’s approval states that the grant date is February 1, the grant date should be determined based on the grant date requirements in ASC 718. As of January 1, 20X1, the requirements for establishing a grant date appear to be met as all of the key terms and conditions have been approved and were communicated within a relatively short time period. Additionally, because it is a restricted stock award (as opposed to an option with an unspecified exercise price), the employees begin to benefit from, or be adversely affected by, subsequent changes in the employer’s stock price on January 1, 20X1.
EXAMPLE SC 2-7
Determining grant date – award authorized prior to first day of employment
SC Corporation offers the position of CEO to an individual on April 1, 20X1, which has been approved by the board of directors. In addition to offering a salary and other benefits, SC Corporation offers 10,000 shares of restricted stock that the prospective CEO would vest in upon completing five years of service. The CEO begins vesting in the award on the date that he begins work.
The individual accepts the CEO position on April 2, 20X1, but does not begin providing services until June 2, 20X1.
What is the grant date of the award?
Analysis
The grant date is June 2, 20X1, when the individual begins employment because the award is for employee service.

2.6.1.1 Grant date for awards with performance conditions

A mutual understanding of the terms and conditions does not exist if the award has a performance condition, but the performance target has not yet been defined. For example, if the performance target has not yet been approved or the target is based on a budget that is not yet approved, the grant date requirements are not met until such approval is obtained. The performance targets also must be communicated to employees (or communicated within a “relatively short time period,” as discussed in SC 2.6.1).
To establish a grant date, performance targets should be objectively determinable and measurable. For example, a mutual understanding of the terms and conditions might not exist if the compensation committee has the ability to adjust, at its discretion, how performance against the performance target will be measured. When assessing if the discretion by the compensation committee (or others with authority over the compensation arrangement) impacts the grant date determination, a company should consider:
  • How often the compensation committee has made adjustments in the past and the nature of those adjustments
  • Whether there are objective criteria for making adjustments to an award
  • Whether the holders of the award have an understanding of when and how the terms of the award will be adjusted

Conditions based on the employee's individual performance also need to be clear and objective. If targets are based on employee evaluations and performance ratings, the evaluation process should be well-controlled and understood by the employee, be reasonably objective, and serve as a basis for promotion and other compensation decisions. Otherwise, the grant date criteria would not be met until the performance evaluation is completed.
Example SC 2-8 and Example SC 2-9 illustrate the determination of a grant date for awards with performance conditions.
EXAMPLE SC 2-8
Determining grant date for an award with a performance condition
On January 1, 20X1, SC Corporation grants options to employees that vest in three tranches based on achieving an EBITDA target in each of the next three years (20X1, 20X2, and 20X3). The target for each year will be approved by the board of directors on January 15 of the respective year. For example, the EBITDA target for 20X1 (the first tranche) is approved on January 15, 20X1. The EBITDA target will be communicated to employees shortly after the approval date. Assume all other terms and conditions of the award are approved as of January 1, 20X1.
What is the grant date of the award?
Analysis
Each tranche of the award has a separate grant date, which is the date the EBITDA target is approved by the board of directors. While there may be a process in place to approve EBITDA targets, because the board of directors has discretion in determining and approving the target, a mutual understanding of the terms and conditions does not exist until the target is approved. The first, second, and third tranches will have a grant date of January 15, 20X1, January 15, 20X2, and January 15, 20X3, respectively.
EXAMPLE SC 2-9
Determining grant date – award with multiple performance targets
On January 1, 20X2, SC Corporation grants restricted stock to an executive that vests at the end of the year based on continued service and achieving the following performance targets:
  • 50% of the shares vest if total revenue growth for 20X2 exceeds 10% as compared to 20X1
  • 50% of the shares vest if the holder of the award achieves “satisfactory progress in developing new products” for the executive's business unit

SC Corporation's process for evaluating “satisfactory progress in developing new products” is highly subjective and the executive is not provided clear guidelines or objective criteria for meeting the target. The decision about whether the target is met will be made by the compensation committee.
What is the grant date of the award?
Analysis
Based on the facts provided, the grant date for the 50% portion of the award that vests based on revenue growth is January 1, 20X2. Even though the executive does not yet know the actual dollar amount of revenue required to achieve the target (as the financial statements for 20X1 have not yet been prepared and total revenue for the year is not yet known), how revenue growth will be calculated is known and objectively determinable and therefore, there is a mutual understanding of the terms and conditions.
However, a grant date for the 50% portion of the award for which vesting depends on satisfactory progress in developing new products will not occur until the compensation committee (1) determines whether the target has been met or (2) establishes and communicates clearer, more objective criteria that will be used to determine if the target has been met, if sooner. This is because there is not a mutual understanding of the terms and conditions of this portion of the award given the highly subjective process for evaluating whether the target has been met.

2.6.2 Requisite service period for stock compensation awards

The fair value of stock-based compensation is recognized in a company’s financial statements over the requisite service period through a charge to compensation cost and a corresponding increase to additional paid-in capital or to a liability, depending on the classification of the award. The requisite service period is the period during which an employee is required to provide service in exchange for stock-based compensation. It could be explicit, implicit, or derived, depending on the terms of the award.
The requisite service period generally commences on the grant date. However, initial recognition of compensation cost may precede the grant date or begin after the grant date in certain circumstances (as discussed in SC 2.6.4 and SC 2.6.5). Additionally, if an award requires future service, the requisite service period is presumed to be only for the future service and expense is recognized prospectively. Therefore, a company cannot conclude that a period before the earlier of the service inception or grant date is part of an award’s requisite service period. However, for an award that is fully vested on the grant date, all compensation cost would be recognized on the grant date.
The requisite service period should be based on an analysis of the award’s terms, as well as other relevant facts and circumstances (e.g., employment agreements, company prior practice). ASC 718-10-55-109 through ASC 718-10-55-115 provides additional details on determining the requisite service period and includes several examples.
Figure SC 2-4 provides definitions and examples of the terms used in ASC 718 to assist in determining the requisite service period.
Figure SC 2-4
Definitions and examples of a requisite service period
Definitions
Examples
Requisite service period
Explicit service period is stated in the terms of the stock-based compensation award.
An award will vest after four years of continuous service that starts on the grant date.
The award has an explicit service period and a requisite service period of four years.
Implicit service period is inferred from an analysis of other terms in the award, including explicit performance or service conditions.
An award will vest upon the completion of a new product’s design that is expected to be finished in 36 months.
The implicit requisite service period is 36 months.
Derived service period is determined based on certain valuation techniques that are used to estimate fair value. This principally applies to awards that have market conditions.
An award will become exercisable if the stock price increases by 100% at any time during a five-year period.
The requisite service period can be derived from a lattice model that is used to estimate fair value.
The requisite service period for an award with a market condition may be derived through certain valuation techniques (e.g., a lattice model). See SC 8.5 for a description of a lattice model. The valuation technique is summarized below:
  • In a lattice model, the derived service period represents the duration of the median (as defined in the next two bullets) of the distribution of stock-price paths on which the market condition is satisfied.
  • The duration is the period of time from the service inception date to the expected date that the market condition will be satisfied (as inferred from the valuation technique).
  • The median is the middle stock-price path (the mid-point of the distribution of paths) on which the market condition is satisfied.

The requisite service period for an award with a service condition may be a derived service period if the award is deep out-of-the-money on the grant date. In that situation, the explicit service period of the award may not be substantive because the employee may be required to provide service for some period of time in order to obtain any value from the award (if retention of the award is effectively contingent on employment because it has a short period of time during which it can be exercised after termination). If a deep out-of-the-money award is determined to also have a derived service period, the requisite service period should be based on the longer of the explicit service period and the derived service period. Generally, the derived service period of a deep out-of-the-money award would be determined by using a lattice model because the award effectively contains a market condition.
Figure SC 2-5 summarizes how an award’s requisite service period may be determined based on the nature of the vesting condition that the award contains.
Figure SC 2-5
Determining requisite service based on an award’s condition
Nature of condition
Potential type of requisite service period
Service condition
Explicit or derived
Performance condition
Explicit or implicit
Market condition
Explicit or derived
Throughout this guide, the terms “vested” and “partially vested” are generally used to describe awards for which the employee has completed the requisite service period or partially completed the requisite service period, respectively. As used within this guide, “vested” or “partially vested” may not be equivalent to legally vested, which represents the date or event upon which the employee has fulfilled the vesting condition and can terminate service from the employer and retain the award.

2.6.3 Expense attribution for stock-based compensation awards

Under ASC 718-10-35-2, compensation cost for an award of share-based compensation is recognized over the requisite service period. This is generally referred to as the “attribution of expense.”
Example SC 2-10 illustrates the attribution of expense.
EXAMPLE SC 2-10
Expense recognition when vesting begins before the grant date
On April 1, 20X1, SC Corporation’s compensation committee approves a stock option award for certain members of management. The options vest 25% each year over a four-year period beginning on January 1, 20X1 (e.g., the first tranche will vest on December 31, 20X1) based only on continued service. The grant date of the options is April 1, 20X1 because approval of the options was obtained and all terms and conditions were known on that date. The service inception date is also April 1, 20X1 because the requirements to establish a service inception date prior to the grant date have not been met. Accordingly, SC Corporation did not record any compensation cost related to the options prior to April 1, 20X1.
The total grant-date fair value of the award is $100,000 and the options are equity-classified. SC Corporation’s policy is to use the straight-line attribution approach to recognize compensation cost for options with graded vesting features and only service conditions (see further discussion in SC 2.8).
Should SC Corporation record a "catch-up" entry on April 1, 20X1 to account for the shortened vesting period in the first year (i.e., the vesting "credit" given for the three months prior to the grant date)?
Analysis
No. SC Corporation should record compensation cost prospectively beginning on the grant date. ASC 718 requires compensation cost to be recognized over the requisite service period. The definition of requisite service period states that if an award requires future service for vesting, a company cannot define a prior period as the requisite service period. Therefore, SC Corporation should not record a "catch-up" entry on April 1, 20X1.
However, SC Corporation will need to consider the requirement in ASC 718-10-35-8 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 legally vested (the "floor" concept). When the first tranche of options vests on December 31, 20X1, SC Corporation should ensure it has recorded at least $25,000 ($100,000 x 25%) of compensation cost related to the award. Therefore, it would be appropriate for SC Corporation to anticipate the "floor" before the legal vesting "trigger" is met and recognize $25,000 of compensation cost ratably over the period from April 1, 20X1 through December 31, 20X1. The remaining $75,000 of compensation cost would be recognized over the period from January 1, 20X2 through the final vesting date.

2.6.4 Service inception date – prior to grant date

The “service inception date” is the first day of the requisite service period and the date on which a company would begin to recognize compensation cost. If the following criteria are satisfied, the service inception date could precede the grant date (ASC 718-10-55-108 through ASC 718-10-55-109):
  • An award is authorized.
  • Service begins before there is a mutual understanding of the key terms and conditions of a stock-based compensation award (e.g., an employee providing service is granted an award where the exercise price will be set at a future date).
  • Either of the following conditions exist:
    • The plan or award’s terms do not include a substantive future requisite service condition on the grant date (e.g., at the grant date the award is vested).
    • The plan or award contains a market or performance condition that if not satisfied during the service period preceding the grant date and following inception of the arrangement results in forfeiture of the award (refer to ASC 718-10-55-114).

For example, an award’s service inception date may precede the grant date when a vested award is issued to an employee but the exercise price is set at a later date. The award’s grant date would be the first date on which the exercise price and the current stock price are known to provide a sufficient basis for the employee to understand and bear the risks and rewards of equity ownership. However, in this fact pattern, the service inception date would be when the award is approved and issued to the employee.
In contrast, if an unvested award with only a service condition is awarded with an exercise price to be determined at a later date and the award requires the employee to provide future service after the date the exercise price is determined, the service inception date would not precede the grant date because the award requires substantive future service. In this scenario, both the service inception date and the grant date would be the date on which the exercise price is known.
If it is determined that the service inception date precedes the grant date, a company should accrue compensation cost beginning on the service inception date. The company should estimate the award’s fair value on each subsequent reporting date (i.e., remeasure each period at fair value) until the grant date. On the grant date, the estimate of an equity-classified award’s fair value is fixed; therefore, the cumulative amount of previously-recognized compensation cost should be adjusted to the grant date fair value, and the company would no longer remeasure the award. If the award is liability classified, it would continue to be marked to fair value each reporting period until settlement.
If an award is cancelled and replaced with a new award during the period prior to the grant date, the company would remeasure fair value as of the issuance of the new award and adjust the cumulative amount of previously-recognized compensation cost.
Figure SC 2-6 summarizes the criteria for establishing the service inception date prior to the grant date.
Figure SC 2-6
Summary of service inception date criteria
Figure 2-6 Summary of service inception date criteria View image
* The reference to the plan in ASC 718-10-55-108 is based on our view that a company could elect to interpret these criteria in the context of the plan as a whole, as opposed to individual awards.
Example SC 2-11 illustrates the determination of whether the service inception date criteria are met.
EXAMPLE SC 2-11
Service inception date – assessing whether the award is authorized
On January 1, 20X1, SC Corporation's board of directors approves an overall compensation plan that includes terms of performance awards to be granted to employees. The performance awards are based on SC Corporation achieving an EBITDA target during 20X1. The employees will vest in the awards if the target is achieved and the employees provide service for two additional years (i.e., through December 31, 20X3). At the time of board approval, the employees are aware of the compensation plan, and that if the EBITDA target is achieved an award will be granted. However, other key terms and conditions, such as the number of awards allocated to each employee, will not be communicated until the end of 20X1. As a result, the grant date criteria are not met until December 31, 20X1.
Are the service inception date criteria met as of January 1, 20X1?
Analysis
It depends. The employees are beginning to provide service and the award contains a performance condition (EBITDA target) that must be achieved prior to the grant date. However, the assessment of whether the award has been authorized requires judgment and careful assessment of the facts and circumstances. A broad interpretation of “authorization” could result in a conclusion that the awards are authorized as of January 1, 20X1 even though the number of awards allocated to each employee has not yet been finalized. This interpretation is based on the fact that (1) the board of directors has approved an overall compensation plan that includes the stock-based compensation awards, and (2) the employees broadly understand the compensation plan, including an awareness that if certain goals are met, there is an expectation that awards will be granted.
Additional factors that may be important to the analysis might include:
  • Whether the compensation plan summarizes the process of how awards will be allocated to the employees and how the number of awards or monetary amount of the awards will be determined (e.g., based on certain performance metrics that are defined or understood either through formally authorized policy or established practices).
  • The substance of the approval process to finalize the award, including the amount of discretion that the board of directors has to deviate from the previously-approved compensation plan.

Conversely, under a narrow interpretation of “authorization,” SC Corporation might conclude that the awards have not been authorized as of January 1, 20X1 because the number of awards granted to individual employees has not yet been authorized.
Although each set of facts and circumstances is unique, in general, we believe that the use of the broad or narrow interpretation described in Example SC 2-11 is an accounting policy and should be applied consistently to all similar awards.

2.6.5 Service inception date–after grant date

The service inception date can also occur after the grant date. Typically, as of the grant date, an employee has begun providing service toward earning an award and therefore, a company should begin recording expense. However, ASC 718-10-55-94 provides an example of a situation when the service inception date is after the grant date. In that example, there is an award consisting of four tranches with the same grant date and four separate annual performance targets. The employee vests in each tranche based on achieving the annual performance target and providing service during the respective year. The example concludes that each tranche should be accounted for as a separate award with its own service inception date as of the beginning of the year to which the performance condition relates. The conclusion is based on the following factors:
  • Each tranche contains an independent annual performance condition that relates to service during the respective separate annual period.
  • The employee's ability to vest in each tranche is not dependent on service beyond the related year.
  • The failure to satisfy the performance condition in any one particular year has no effect on the vesting of any preceding or subsequent period's tranche.

We believe this conclusion should only be applied to fact patterns in which all of the above factors are present.

2.6.6 Service completion date for stock-based compensation awards

The requisite service period generally ends on the service completion date. The service completion date occurs when an employee completes the requisite service period (i.e., the employee is no longer required to provide any additional service to retain the award). For example, for an award with an explicit service condition, the service completion date is the final date that an employee is required to be employed by the company in order to retain the award. In contrast, the service completion date for an award with an implicit performance condition would be the date that an employee achieves the target specified in the award’s terms while being employed by the company. The service completion date of an award with a market condition is usually the earlier of (1) the date on which the market condition is satisfied or (2) the date on which the derived service period is completed, even if the market condition is not satisfied.

2.6.7 Awards with accelerated vesting upon retirement

Many companies have plans with terms that provide for the vesting of an employee’s awards when the employee retires (e.g., defined parameters for eligible retirements, such as the sum of age and years of service), sometimes with immediate exercisability or alternatively, with exercisability following the original vesting schedule without a requirement for continued service. In those cases, the service completion date is the date that the employee is eligible to retire, not the probable or actual date of retirement, because the employee is not required to provide any future service beyond that eligibility date in order to retain the award.
For awards granted to retirement-eligible employees where no service is required for the employee to retain the award, application of ASC 718-10-55-87 through ASC 718-10-55-88 results in the immediate recognition of compensation cost at the grant date because the employee is able to retain the award without continuing to provide service. This may also be relevant in assessing whether a service inception date has been achieved prior to grant date (see SC 2.6.4). For employees near retirement eligibility, attribution of compensation cost should be over the period from the grant date to the retirement eligibility date.
A company should consider other terms of an award that could impact the date the employee is eligible to retire, such as a required notice period. For example, if a retirement-eligible employee must provide six months’ notice before their retirement date, the initial service period is six months. We believe a company could recognize all of the compensation expense over six months in this fact pattern. Alternatively, the company could continuously update its estimate of the service period each reporting period if the employee has not yet given notice (i.e., the revised estimate would extend six months from the reporting date), with updates to the estimate accounted for on a prospective basis. A company should apply its policy consistently to similar awards. It would not be appropriate for a company to estimate when they expect the employee to retire and recognize compensation expense over that estimated period.
Unlike the attribution of compensation cost, when estimating the probable retirement date would be inappropriate, the expected vesting (i.e., retirement) date, as well as expected exercise behavior, will be necessary to determine the expected term assumption in measuring the fair value of the award.

2.6.8 Noncompete provisions in stock-based compensation awards

In some situations, compensation arrangements may contain noncompete provisions. Under a typical noncompete provision, the employee may be required to return the award (or the cash equivalent) if the employee terminates employment with the company and is subsequently employed by a competitor during the term of the noncompete agreement. Examples 10 and 11 of ASC 718-20-55-84 through ASC 718-20-55-92 illustrate the accounting for stock-based compensation awards that include noncompete provisions.
In Example 10, the FASB concluded that the noncompete provision does not compel the employee to provide service and therefore does not affect the requisite service period. This noncompete provision is treated as a clawback feature, which is accounted for if and when the employee violates the noncompete provision and the award or the cash equivalent are returned. Thus, the compensation cost associated with the award is recognized based on the stated vesting terms, without consideration of the noncompete agreement. If the award is fully vested upon issuance, or if the recipient is retirement-eligible, compensation cost is recognized immediately.
Conversely, in Example 11, the FASB concluded that the noncompete provision essentially creates an in-substance requisite service period because the facts and circumstances indicate that the employee was essentially in the same position as they would have been if an explicit vesting period had existed. In other words, the noncompete provision functions as an in-substance vesting condition. In this example, even if the award was fully vested, or the recipient was retirement eligible, compensation cost would be recognized over the term of the noncompete agreement.
A noncompete provision creates an in-substance requisite service period if it compels the employee to continue providing service to the company in order to receive the award. The fact that the noncompete provision is substantive is not, by itself, sufficient to conclude that the provision compels the employee to remain in active service.
When assessing the impact of noncompete provisions, companies should consider:
  • The amount of the stock-based compensation award as compared to the employee’s other compensation. In Example 11 of ASC 718-20-55-87 through ASC 718-20-55-92, the stock-based compensation award has a value that is four times greater than the employee’s annual cash compensation. The greater the relative value of the stock-based compensation award, the more likely it is that the employee would continue to provide service to the company in order to receive the award.
  • The severity of the effect of the noncompete agreement on the employee's ability to gain employment elsewhere.
  • The company's intent and ability to enforce the noncompete and the company's past practice of enforcing noncompete agreements.
  • The ability of the employee to obtain access to the award (e.g., whether the award is subject to a delayed-transfer schedule that coincides with the period of the non-compete agreement).
  • Employer's past practice with respect to employees who may have violated the noncompete agreements (if relevant).
  • Circumstances specific to the individual employees.

In our experience, most noncompete provisions do not create an in-substance service condition. This may be an appropriate presumption unless there is persuasive evidence that the provision compels the employee to remain in active service to receive the award. We expect that instances when a noncompete provision creates an in-substance service condition will be rare.

2.6.9 Multiple service periods in stock-based compensation awards

Awards with multiple market, performance, or service conditions may have terms that specify multiple service periods. For accounting purposes, however, an award can have only one requisite service period.
A company should develop its estimate of the requisite service period based on an analysis of (1) all vesting and exercisability conditions, (2) all explicit, implicit, and derived service periods, and (3) the probability that performance or service conditions will be satisfied (ASC 718-10-55-72). Figure SC 2-7 summarizes this analysis.
Figure SC 2-7
Determining a requisite service period for an award with multiple explicit, implicit, or derived service periods
Conditions
Requisite service period
  • Market condition
and
  • Either performance or service conditions that are probable of being satisfied
Longest of the explicit, implicit, or derived service periods, because all of the conditions need to be satisfied.
  • Market conditions
or
  • Either performance or service conditions that are probable of being satisfied
Shortest of the explicit, implicit, or derived service periods, because vesting occurs upon satisfaction of any of the award's conditions.
If an award contains both a market and a performance condition, but the performance condition is not probable of being satisfied, compensation cost is not recognized until the performance condition becomes probable. An example is an award granted by a nonpublic company that vests only upon a liquidity event (performance condition -- e.g., an initial public offering or change in control) and the achievement of a specified internal rate of return (IRR) to the existing principal shareholder (typically, a private equity firm) (market condition). As discussed in SC 2.5.3, the liquidity event would not be considered probable until the date it occurs. Therefore, no compensation cost would be recognized related to this award until the liquidity event occurs. At that date, compensation cost equal to the grant-date fair value (assuming all criteria for equity classification are met) would be recorded, regardless of whether the market condition is satisfied.

2.6.10 Changes to the requisite service period of awards

A company may change its initial estimate of the requisite service period based on the original terms of the award. See SC 4.3.6 for a discussion of modifications to an award that may affect the award’s requisite service period.
Figure SC 2-8 summarizes when a company can change its estimate of the requisite service period for an equity-classified award, as described in ASC 718-10-55-77 through ASC 718-10-55-79.
Figure SC 2-8
Changes to the requisite service period for an equity-classified award
Basis for initial estimate of the requisite service period
Required change to the requisite service period
Performance or service condition
Change the requisite service period if subsequent information indicates that:
  • It is probable that the performance condition will be achieved within a different time period
or
  • Another performance or service condition becomes the probable outcome
Market condition
Do not change the requisite service period unless the market condition is satisfied before the end of the initially estimated requisite service period
Market condition and a performance or service condition
[The initial estimate of the requisite service period is based on the market condition's derived service period.]
Do not change the requisite service period unless:
  • The market condition is satisfied before the end of the derived service period
or
  • Satisfying the market condition is no longer the basis for determining the requisite service period
The requisite service period for a liability-classified award is generally updated each reporting period in conjunction with the remeasurement of the award.
We believe that for liability-classified awards with market conditions that have a derived service period, there are two acceptable alternatives that can be applied:
  • Periodic update method: Revise the remaining service period each reporting period in conjunction with the remeasurement of the award.
  • Grant date method: Do not update the service period; in other words, the estimate of the requisite service period at the grant date (or service inception date if that date precedes the grant date) is not changed in future periods when the lattice model is updated for changes in measuring the fair value of liability-classified awards.

The choice of an approach is an accounting policy election that must be applied consistently.

2.6.11 Recognition effect of changes to requisite service period

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?
Analysis
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?
Analysis
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?
Analysis
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.

PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.

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