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The basic measurement principle for liability-classified awards is fair value, the same as it is for equity-classified awards. As discussed in SC 6.2.2, a nonpublic company may make an accounting policy election to use intrinsic value to measure its liability-classified awards. However, a liability-classified award differs from an equity-classified award, which is generally measured at fair value on the grant date, in that it is remeasured to an updated fair value at each reporting period until the award is settled. For a liability-classified award, a company would do the following:
  • Measure the fair value of the award on the grant date.
  • Recognize compensation cost over the requisite service period.
  • Remeasure the fair value of the award each reporting period until the award is settled.
  • True up compensation cost each reporting period for changes in fair value pro-rated for the portion of the requisite service period rendered.
  • Once vested (i.e., the requisite-service period is complete), immediately recognize compensation cost for any changes in fair value until settlement.
As discussed in SC 8.2, the fair value of a share-based payment is measured using an option pricing model and includes both the intrinsic value and time value of the award. As employees vest in liability-classified awards and the remaining time until settlement or expected settlement of the award decreases, the time value of these awards will decrease and approach zero until, on the settlement date, the awards' fair value will equal intrinsic value.
Example SC 3-1 illustrates the accounting for liability-classified awards.
EXAMPLE SC 3-1
Initial measurement and subsequent measurement of a liability award
On January 1, 20X1, SC Corporation grants 100 of its employees 100 cash-settled stock appreciation rights (SARs) for a total of 10,000 SARs. Each SAR entitles the employee to receive cash equal to the increase in value of the underlying stock over $20 (the current stock price). The SARs will cliff-vest when the employees complete three years of service. SC Corporation determines that, based on the awards' service condition, the requisite service period is three years.
Using an option-pricing model, SC Corporation determines that the grant-date fair value of each SAR is $5. Because the awards were granted with no intrinsic value (i.e., "at the money"), the SAR's fair value of $5 consists entirely of time value. The SARs' aggregate fair value is $50,000 on January 1, 20X1, the grant date.
On December 31, 20X1, the end of the first year of the requisite service period, SC Corporation determines that the SAR's fair value is $6 per SAR ($60,000 in total).
For simplicity, consideration of forfeitures has been excluded.
How much compensation cost should SC Corporation record in the first year related to the SARs?
Analysis
Because the employees completed one-third of the requisite service period by December 31, 20X1, SC Corporation would recognize $20,000 (10,000 SARs × $6 fair value of each SAR × 1/3 portion vested) of compensation cost.
At the end of each subsequent reporting period over the next two years, SC Corporation will continue to remeasure the current fair value of the award and adjust cumulative compensation expense to the appropriate portion of the total fair value in relation to the portion of the requisite service period that has been completed.
For reporting periods after the requisite service period is completed, SC Corporation would continue to remeasure the SAR's fair value, recognizing the entire change in fair value (positive or negative) immediately in the income statement because the SAR is fully vested. That remeasurement process continues until settlement.
On the settlement date, SC Corporation would remeasure the SARs' fair value (which should be equal to the intrinsic value) and recognize the change in fair value as an adjustment to compensation cost.

3.2.1 Awards with performance and market conditions

Accounting for vesting conditions of liability-classified awards follows the same principles as equity-classified awards (discussed in SC 2). Assuming all conditions for a grant date have been met, a company should begin recognizing compensation cost for liability-classified awards with performance conditions when it becomes probable that the performance condition will be met. The measurement of compensation cost, however, would be based on the fair value of the award at each reporting date (i.e., remeasured each period) and the portion of the requisite service period completed.
For liability-classified awards with a market condition, the same periodic remeasurement approach applies, with the impact of the market condition incorporated into the determination of fair value each period. However, if the market condition is not satisfied, the fair value on the settlement date will be zero; therefore, on a cumulative basis, the company would recognize no compensation cost. This is in contrast to an equity-classified award with a market condition, for which the minimum amount of compensation cost to be recognized is the grant-date fair value even if the market condition is not satisfied (subject to satisfaction of the requisite service period).
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