Some stock-based compensation awards include graded vesting features such as the award described in Example SC 2-16. Graded vesting is defined as an award that vests in stages (or tranches). This is in contrast to cliff vesting, in which an award vests in its entirety on a specific date. In concept, an award that vests in tranches can be thought of as a series of individual awards with different cliff-vesting dates.
Economically, an award with graded vesting is different than a single award with a single cliff-vesting date for the entire award.
However, for an award with graded vesting that is subject only to a service condition (e.g., time-based vesting), ASC 718-10-35-8
provides an accounting policy choice between either graded vesting attribution or straight-line attribution:
- The graded vesting method: A company concurrently recognizes compensation cost over the requisite service period for each separately-vesting tranche as though each tranche of the award is, in substance, a separate award. This will result in an accelerated recognition of compensation cost.
- The straight-line method: A company recognizes compensation cost on a straight-line basis over the total requisite service period for the entire award (i.e., over the requisite service period of the last separately-vesting tranche of the award).
A company should apply its policy consistently for all awards with similar features.
Under either attribution method, the amount of compensation cost that is recognized as of any date should at least equal the grant-date fair value of the vested portion of the award on that date. That is, if a company elects the straight-line method and the expense recognized to date is less than the grant-date fair value of the award that are legally vested at that date, the company will need to increase its recognized expense to at least equal the fair value of the vested amount. This is generally referred to as the “floor” concept. If a company estimates forfeitures, but actual forfeitures are less than the estimate, that may also affect the analysis of when the floor will require an increase to the compensation cost recognized to date.
For awards with graded vesting, a company can either estimate separate fair values for each tranche based on the expected term of each tranche or estimate fair value using a single expected term assumption for the entire grant (see SC 9.3
). ASC 718-20-55-26
permits a company to choose either attribution method for awards with only service conditions, regardless of the company’s choice of valuation technique. If a company estimates separate grant-date fair values for each tranche of the award, the fair value estimates specific to the tranche should be utilized in determining the minimum amount of compensation cost to be recognized.
If awards with market or performance conditions include graded vesting features, the graded vesting method should be used and the straight-line method should not be used. Additionally, if an award includes both a service condition and a market or performance condition, the graded vesting method should be used. Companies that grant awards with market or performance conditions and use the graded vesting method and then modify such awards to remove the market or performance conditions, should attribute the remaining compensation cost in accordance with its attribution policy for awards with only service conditions. Therefore, if the company’s attribution policy for awards with only service conditions is the straight-line approach, following modification of the award, the remaining compensation cost should be attributed using the straight-line approach.
The application of the graded vesting method of attribution is illustrated in Figure SC 2-9.
Figure SC 2-9
Award with four tranches that vests 25% each year over four years
Percent of compensation cost recognized each year
Example SC 2-18, Example SC 2-19, Example SC 2-20, Example SC 2-21 and Example SC 2-22 illustrate the accounting for awards with various vesting conditions as well as graded vesting provisions.
EXAMPLE SC 2-18
Awards with vesting that accelerates upon a change in control or IPO
SC Corporation grants stock options to employees that vest 25% each year over a four-year period. The stock options include a provision under which vesting will immediately accelerate upon a change in control of the company or an IPO. SC Corporation’s accounting policy is to attribute expense using the straight-line method for awards with graded vesting features and only service conditions.
Can SC Corporation apply the straight-line method of attribution to recognize compensation cost for the options?
Yes. Although the change-in-control or IPO provision is a performance condition, the presence of which would ordinarily disqualify the use of the straight-line method for graded vesting awards, we believe this particular type of performance condition does not preclude the use of the straight-line method. This is because events such as an IPO or change in control are generally considered to be outside the control of the company and are not considered probable until they occur, as well as the fact that the IPO is not a vesting contingency (i.e., the award will vest even without an IPO), but rather just accelerates vesting.
If this award had contained other types of performance conditions that accelerate vesting (e.g., achievement of a performance target) or if the IPO condition was a vesting contingency rather than an acceleration event (as described in Example SC 2-22), the straight-line method could not be utilized.
EXAMPLE SC 2-19
Attribution of expense for an award with “back-loaded” vesting
SC Corporation grants 100,000 stock options to employees that vest based on the following schedule:
- Year 1 - 10%
- Year 2 - 20%
- Year 3 - 30%
- Year 4 - 40%
The options are equity classified and vest based only on continued service. The grant-date fair value per option is $10. SC Corporation’s accounting policy is to attribute expense using the straight-line method for awards with graded vesting features and only service conditions.
How much compensation cost should SC Corporation record each year, excluding the impact of forfeitures?
For a four-year service period, the straight-line method results in recognizing 25% of the total compensation cost, or $250,000 ((100,000 options x $10 fair value) ÷ 4 years), each year, excluding the impact of forfeitures. Even though only 10% of the awards are legally vested as of the end of Year 1, it would not be appropriate to recognize only 10% of the compensation cost because SC Corporation’s accounting policy is to use the straight-line method of attribution. The straight-line method requires recognizing the total compensation cost evenly over the total vesting period (the requisite service period of the last separately-vesting tranche of the award).
EXAMPLE SC 2-20
Application of the “floor” concept to a graded vesting award
SC Corporation grants 100,000 stock options to employees that vest 25% each year over a four-year period based only on continued service. The options are equity classified and have a grant-date fair value per option of $10 (total compensation cost of $1,000,000). SC Corporation’s accounting policy is to attribute expense using the straight-line method for awards with graded-vesting features and only service conditions. SC Corporation elects to estimate forfeitures and therefore, begins recognizing $970,000 of compensation cost ratably over the four-year service period based on its forfeiture estimate.
At the end of Year 1, none of the employees have terminated employment; however, SC Corporation still believes its estimate of total compensation cost for the award, including estimated forfeitures, is reasonable.
How much compensation cost should SC Corporation record in Year 1?
SC Corporation must recognize $250,000 ($1,000,000*25%) of compensation cost in Year 1 because 25% of the awards are legally vested. Applying the straight-line attribution method results in recording only $242,500 ($970,000*25%) of compensation cost in Year 1 based on SC Corporation’s estimate of total compensation cost; however, SC Corporation must consider the “floor” concept and record an additional $7,500 of expense for a total of $250,000 in Year 1.
EXAMPLE SC 2-21
Attribution of expense for an award with “front-loaded” vesting
On July 1, 20X1, calendar year SC Corporation grants restricted stock with a fair value of $300. The award contains a three-year service condition that vest based on the following schedule:
- 50% vests after year 1 (June 30, 20X2)
- 25% vests after year 2 (June 30, 20X3)
- 25% vests after year 3 (June 30, 20X4)
SC Corporation elects the straight-line attribution method as permitted under ASC 718-10-35-8
requires "the amount of compensation cost recognized at any date must at least equal the portion of the grant-date fair value of the award that is vested at that date" (i.e., the “floor”). Therefore, SC Corporation must recognize at least $150 of compensation cost at June 30, 20X2 (50% of the original $300 grant date fair value), rather than $100 which would result from a simple 3-year straight-line calculation.
For attribution purposes, should the “floor” imposed by ASC 718-10-35-8
be anticipated before the legal vesting ’trigger’ is met?
Yes. SC Corporation should anticipate the floor before the legal vesting ’trigger’ is met. SC Corporation should begin to recognize the year 1 expense (contemplating the $150 floor) ratably since the terms of the arrangement call for 50% to vest during that period. Thus, SC Corporation would begin recognizing $37.50 ($150/4 quarters) each quarter during the first year of service.
EXAMPLE SC 2-22
Attribution of expense for awards with performance and service conditions
On January 1, 20X1, SC Corporation grants 100,000 stock options to employees that vest based upon service and achieving an IPO (a performance condition). Under the service condition, 25% of the stock options vest each year over a four-year period. SC Corporation does not record compensation cost during 20X1 due to the IPO performance condition. During 20X2, SC Corporation completes an IPO. After achieving the performance condition, the options continue to vest based only on service according to the graded vesting schedule.
Can SC Corporation apply the straight-line method of attribution to recognize compensation cost in 20X2 and future years?
No. The award contains a performance condition in addition to the time-based graded vesting service condition; therefore, the straight-line method cannot be used. Although only the service condition remains after the performance condition is satisfied in 20X2, the use of the straight-line method is not permitted for this award because the award contains both conditions. SC Corporation should begin recognizing compensation cost for the options using the graded vesting method once the IPO occurs with a cumulative catch-up for the service period completed to date.
Note that this example differs from Example SC 2-18 in that both the performance and service condition are required for vesting. In Example SC 2-18, the change-in-control performance condition accelerated vesting, but is not a vesting requirement.