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The criteria for determining whether an award should be classified as a liability or as equity are outlined in ASC 718-10-25-6 through ASC 718-10-25-18. The following are the types of awards that companies should classify as liabilities:
  • An award with conditions or other features that are indexed to something other than a market, performance, or service condition.
  • An award that meets certain criteria of ASC 480, Distinguishing liabilities from equity.
  • A share award with a repurchase feature that permits an employee to avoid bearing the risks and rewards normally associated with equity ownership for a reasonable period of time by allowing the employee to put shares to the company within six months after the employee vests in the shares
or
A share award where it is probable that the employer would prevent the employee from bearing the risks and rewards normally associated with stock ownership within six months after share issuance.
  • An option or similar instrument that could require the employer to pay an employee cash or other assets, unless cash settlement is based on a contingent event that is (a) not probable and (b) outside the control of the employee.
  • An option or similar instrument in which the underlying shares are classified as liabilities.

3.3.1 Other than market, performance, or service condition awards

In some cases, an award's vesting or exercisability may be indexed to a factor that is in addition to the company's stock price (e.g., dual-indexed awards). If the factor is not a market, performance, or service condition, the award should be accounted for as a liability, in essence a derivative. Also, an award would be dual-indexed if it contains a performance condition that is measured against a different measure of performance of another entity or group of entities. A condition other than a market, performance, or service condition should be reflected in estimating the fair value of the award. The following are examples of awards that are indexed to something other than a market, performance, or service condition:
  • A stock option with an exercise price that is indexed to the market price of a commodity (e.g., platinum, soybeans, live cattle).
  • An award that vests based on the appreciation in the price of a commodity (e.g., natural gas) and the company’s shares and is thus indexed to both the value of that commodity and the company’s shares.
  • A stock option with an exercise price that is indexed to the Consumer Price Index, some other measure of inflation, or another external index.
  • An award that vests based on the company’s EBITDA growth exceeding the average growth in net income of peer companies over the next three years.
  • An award that vests based on the company achieving a specified level of growth in revenue in excess of the increase in inflation (i.e., “real” growth).
Note that in the first two examples above, the award would be liability-classified even if the entity granting the share-based payment award is a producer or user of the commodity whose price changes affect the entity’s results of operations and overall entity value. In other words, there is no exception to the liability-classification guidance for an index that is “clearly and closely related” to the entity’s operations.

3.3.2 Certain criteria in ASC 480 applicable to stock awards

ASC 480 provides guidance for determining whether certain freestanding financial instruments are classified as liabilities and generally excludes stock-based compensation from its scope. However, ASC 718 requires companies to apply the classification criteria in ASC 480-10-25 and paragraphs ASC 480-10-15-3 through ASC 480-10-15-4 when determining whether stock-based compensation awards should be classified as a liability unless ASC 718-10-25-6 through ASC 718-10-25-18 require otherwise.

3.3.2.1 Overview of ASC 480 and related stock award examples

ASC 480 specifies that financial instruments within its scope embody obligations of the issuer and should be classified as liabilities. Figure SC 3-1 summarizes three types of freestanding financial instruments that companies should classify as liabilities by reference to ASC 480-10-25 and paragraphs ASC 480-10-15-3 through ASC 480-10-15-4.
Figure SC 3-1
Examples of freestanding financial instruments classified as liabilities
Instruments classified as liabilities
Examples
Mandatorily redeemable financial instruments
ASC 480 defines "mandatorily redeemable" as an unconditional obligation requiring the issuer to redeem the instrument by transferring its assets at a specified or determinable date (or dates) or upon an event that is certain to occur
  • Preferred stock that must be redeemed on a specified date
  • Common stock that must be redeemed upon the employee's death or termination of employment (unless the instrument is issued by a nonpublic non-SEC registrant and is excluded from the scope of ASC 480)
Obligations to repurchase a company's equity shares by transferring assets
  • A written put option on the company's equity shares that requires physical or net-cash settlement
  • A forward purchase contract for the company's equity shares that requires cash settlement
  • Compound instruments, other than outstanding shares, such as a collar that includes a written put option
Certain obligations to issue a variable number of the company's shares
A financial instrument that meets both of the following conditions:
(1) the company must or could settle the obligation by issuing a variable number of its shares, and
(2) the obligation's monetary value is based solely or predominantly on any of the following factors at the obligation's inception:
  • A fixed monetary amount that is known at the obligation's inception (e.g., a fixed dollar amount settled in a variable number of shares)
  • Variations in something other than the fair value of the company's shares (e.g., the price of silver or corn or the free cash flow of the company)
  • Variations in the fair value of the company's equity shares, but moves in the opposite direction
  • An arrangement under which the company will settle a bonus that is a fixed dollar amount by issuing a variable number of shares based on the stock price at the time of settlement

3.3.2.2 ASC 480 scope exceptions on stock awards

The FASB excluded from the scope of ASC 480 nonpublic, non-SEC registrants' financial instruments that will be mandatorily redeemable upon the occurrence of an event that is certain to take place (e.g., the death or termination of service of the holder). For additional guidance, refer to SC 6.3, which discusses how this scope exception specifically impacts nonpublic companies.

3.3.2.3 Obligations based on a fixed monetary amount

As noted in Figure SC 3-1 one of the types of instruments subject to liability accounting under ASC 718 (by reference to ASC 480) is an obligation that is based solely or predominantly on a fixed monetary amount that is known at the obligation's inception. A straightforward example of this type of instrument is a bonus based on a fixed dollar amount that will be settled by issuing shares on the vesting date, with the number of shares to be determined based on the company’s stock price on the settlement date. In this example, the company would generally record compensation cost for the fixed dollar amount of the award over the vesting period, with a corresponding liability. Note that while recognition and measurement of compensation cost for these awards are subject to the general grant date criteria described in SC 2.6.1, the criterion that the employee must begin to benefit from, or be adversely affected by, subsequent changes in the employer’s stock price does not apply to this type of award. This is because the award is based on a fixed monetary amount; its value will never be affected by changes in the stock price.
More complex instruments will need to be carefully analyzed to determine whether the obligation is based predominantly on a fixed monetary amount. For example, a company grants an equity-settled award that vests based on a market condition; however, the company also establishes a dollar-value cap on the award that may limit the number of shares to be issued upon settlement. As a result, in certain outcomes, the value of the award on the settlement date will vary based on the company's stock price (i.e., if the value of the equity is less than the cap), while in other outcomes, the value of the award will be based on a fixed dollar amount (i.e., if the value of the equity exceeds the dollar-value cap). In this scenario, the company should assess whether the dollar-value cap is a predominant feature of the award. To accomplish this, one approach is to use a lattice model to determine the percentage of possible outcomes that would result in the award being settled in the amount of the dollar cap. If the company concludes that the dollar cap feature is predominant, the award should be classified as a liability. See FG 5.5.1.1 for further discussion on the meaning of “predominant.”
Example SC 3-2 and Example SC 3-3 illustrate awards that have a range of potential payouts, and the impact on the classification of the award.
EXAMPLE SC 3-2
Awards with a range of potential payouts based on increase in EBITDA
SC Corporation grants its CEO an award of restricted stock on January 1, 20X1. The ultimate dollar value of the award depends on the percentage increase in SC Corporation’s EBITDA during 20X1. SC Corporation will issue the following value of common stock on December 31, 20X1 based on the specified increases in its EBITDA during 20X1.
Increase in EBITDA
Dollar amount of award
greater than 20%
$1.0 million
between 15% and 20%
$0.8 million
between 10% and 15%
$0.5 million
between 5% and 10%
$0.2 million
less than 5%
$0
The award will be settled only in shares of SC Corporation common stock valued based on the stock price on December 31, 20X1 (the date the shares will be issued). In other words, the dollar amount of the award will be divided by the stock price on December 31, 20X1 to yield the number of shares that will be issued to the CEO.
How should SC Corporation account for the performance award to the CEO?
Analysis
The award should be accounted for as a liability award with a performance condition. An award based on a fixed dollar amount is a liability in accordance with ASC 480-10-25-14. Liability classification is also appropriate for an award that has several possible fixed dollar amount settlements that are not solely or predominantly based on the value of the company’s shares. In this case, the monetary value of the award fluctuates based on changes in EBITDA, not stock price. The award will be settled with a variable number of shares based on the then-current stock price, and therefore is a liability award.
Expense would not be recognized until achievement of one of the performance targets is deemed probable. The expense to be recognized would be based on SC Corporation's best estimate of the ultimate outcome at the end of each reporting period. Once the number of shares has been fixed (in this case when the shares are issued), the award would be reclassified to equity.
EXAMPLE SC 3-3
Awards with a range of potential payouts based on increases in stock price
SC Corporation grants its CEO an award of common stock on January 1, 20X1. The value of the award depends on the percentage increase in SC Corporation’s stock price during 20X1. SC Corporation will issue the following amount of common stock on December 31, 20X1 based on the specified increases in its common stock price during 20X1.
Increase in EBITDA
Dollar amount of award
greater than 20%
$4 million
between 15% and 20%
$3.5 million
between 10% and 15%
$3 million
between 5% and 10%
$2.5 million
less than 5%
$0
The award will be settled only in shares of SC Corporation common stock valued based on the stock price on December 31, 20X1 (the date the shares are issued). In other words, the dollar amount of the award will be divided by the stock price on December 31, 20X1 to yield the number of shares that will be issued to the CEO.
How should SC Corporation account for the award to the CEO?
Analysis
The award should be accounted for as an equity award with a market condition. An award based on a fixed dollar amount (or a dollar amount predominantly based on changes other than in the company’s stock price) is a liability; however, given the number of potential outcomes within the range, which increase directionally with the value of the stock, the award given to the CEO is more akin to a stock-settled SAR than to stock-settled debt (described in ASC 480-10-25-14(a)).
When evaluating if an award is akin to a stock-settled SAR, a company should consider the range of potential settlement values, not just the number of scenarios. The potential outcomes should not be so close together that, in substance, there is only one outcome. Also, the outcomes should not be so far apart that all but one of the outcomes are non-substantive.

3.3.3 Shares with repurchase features

A repurchase feature gives the employee the ability to put (redeem) the shares to the company for cash or gives the company the ability to call (repurchase) the shares for cash. Under ASC 718, companies should evaluate the terms of their share awards that contain repurchase features in order to determine whether liability classification of an award is required, as described below.
A company should classify a share that is puttable by the employee or callable by the employer as a liability if either of the following conditions is met:
  • The employee can avoid bearing the risks and rewards normally associated with equity ownership (as a result of the repurchase feature), for a reasonable period after the share's issuance.
  • It is probable that the employer will prevent the employee from bearing the risks and rewards normally associated with equity ownership for a reasonable period after the share's issuance.
An employee begins to bear the risks and rewards of stock ownership when, for example, an employee receives shares upon exercise of an option or vests in a restricted stock award. ASC 718 defines a reasonable period as a minimum of six months.
An employee put right would allow the employee to avoid bearing the risks and rewards of stock ownership for a reasonable period if the employee can put shares to the company (1) at fair value within six months after the employee vests in the shares (or exercises a vested option) or (2) either before or after six months, at a fixed redemption amount or another amount that is not based on variations in the company’s stock price. The probability of the employee exercising the put right is not a relevant factor. If the repurchase price is an amount other than fair value (e.g., derived using a formula), the share-based arrangement should generally be classified as a liability because the price is not based on variations in the company’s stock price, and, therefore, the employee is not bearing the risks and rewards of stock ownership (regardless of how long the employee holds the shares). There is a limited exception for certain nonpublic company plans that qualify as book value plans. Refer to SC 6.4 for a discussion of book value plans. If a repurchase feature gives the employee the right to put shares back to the company after six months for the fair value of the shares at the date of repurchase plus a fixed amount, the repurchase feature would not cause the award to be classified as a liability; however, ASC 718-10-55-85 provides that the fixed amount over the fair value should be recognized as additional compensation cost over the requisite service period with a corresponding liability.
An employer call right may require liability classification of an award if it is probable that the employer will exercise the call right (1) within six months of the issuance of a vested share (or exercise of a vested option) or (2) either before or after six months at a fixed redemption amount or another amount that is not based on variations in the company’s stock price . When assessing whether it is probable that an employer will prevent the employee from bearing the risks and rewards of stock ownership, we believe the following factors should be considered:
  • How the repurchase price will be calculated.
  • Management's stated representation regarding its intent to call the shares.
  • The frequency with which the employer has called shares in the past.
  • The circumstances under which the employer has called shares in the past.
  • The existence of any legal, regulatory, or contractual limitations on the employer's ability to repurchase shares.
  • Whether the employer is a closely held, private company with a policy that shares cannot be widely held, which would indicate an increased likelihood that the employer will repurchase the shares.
If a share award is classified as a liability because of a repurchase feature and either (a) the put or call feature expires unexercised or (b) at least six months have passed since the employee began bearing the risks and rewards of stock ownership, the award should be reclassified as equity (assuming it meets all other requirements for equity classification). A change in classification to an equity award should be accounted for as a modification (see guidance in SC 4.4).
If a share award with repurchase features is classified as equity, SEC registrants should also consider whether classification of the award as temporary equity is appropriate. See SC 3.3.10 for further guidance.
Example SC 3-4 illustrates the accounting for an award that has an in-substance put option exercisable by the employee immediately upon vesting.
EXAMPLE SC 3-4
Classification of an award that may be deferred upon vesting and placed in a rabbi trust
SC Corporation grants an employee nonvested stock that vests in three years. Upon vesting, the employee may choose to take delivery of the stock, or defer receipt of the stock and have the shares placed in a rabbi trust.
The terms of the rabbi trust permit the employee to immediately diversify by exchanging the shares into investments in nonemployer securities held by the rabbi trust. In that circumstance, the arrangement will ultimately be settled in the future in cash in relation to the value of the diversified investments.
Prior to vesting and deferral in the rabbi trust, should the nonvested stock award be classified as a liability under ASC 718?
Analysis
Yes. Because the employee has the ability, immediately upon vesting, to elect to diversify the stock into nonemployer securities, which will ultimately be settled in cash, we believe the stock compensation arrangement should be classified as a liability. While this fact pattern is not technically an employee put feature, we believe the substance is the same, in that it allows the employee to elect cash settlement from SC Corporation without bearing the risks and rewards of share ownership for six months from the vesting date.
Conversely, if the employee must hold the employer stock within the rabbi trust for six months prior to diversifying, the employee is subject to risk and rewards of share ownership for a reasonable period of time after the share is issued. In that fact pattern, the nonvested stock award would not be classified as a liability prior to its deferral in the rabbi trust. However, public companies would recognize the award in temporary equity, following the guidance in ASC 480-10-S99-3A.

3.3.3.1 Share repurchase upon occurrence of a contingent event

ASC 718 also provides guidance regarding shares with repurchase features that can be exercised only if a contingent event occurs. Under ASC 718-10-25-9, an award with a repurchase feature that can only be exercised upon a contingent event that is (1) not probable and (2) outside the control of the employee would be equity classified. The probability of the contingent event occurring should be reassessed each reporting period. For example, a put feature that an employee can exercise upon an initial public offering would not require liability accounting until and unless it becomes probable that the initial public offering will occur prior to the employee bearing the risk and rewards of stock ownership for at least six months. Because an initial public offering is not probable until it occurs (i.e., until the offering closes), liability accounting would begin on the date of the initial public offering.
It is common for employer call rights to exist that are exercisable only upon termination of an employee's employment (for any reason). Although the employee may have the ability to voluntarily terminate (and thus control the contingent event), in the case of an employer call right, the company should consider the probability of whether the call is expected to be exercised prior to the employee bearing the risks and rewards of ownership for a reasonable period of time (six months).
Example SC 3-5 illustrates the determination of the classification for an award that has a call feature exercisable upon employee termination.
EXAMPLE SC 3-5
Classification of an award with a call feature upon employee termination
SC Corporation grants a nonvested stock award to an employee with a two year vesting period. The award contains a call feature that permits the company to repurchase any vested shares at fair value in the event the employee terminates employment. The company has stated it would likely exercise the call in the event the employee terminates, even if termination is within six months of vesting (though the company would make this ultimate assessment if and when the termination occurs). The company does not currently believe it is probable the employee will terminate while holding immature shares,  and likewise does not believe it is probable the call will be exercised before the employee has borne the risks and rewards of equity ownership for at least six months.
Should SC Corporation classify this award as a liability?
Analysis
While it is probable that the employee will ultimately terminate employment at some point, and the company has acknowledged its likely intent to exercise the call if the employee were to terminate, since it is not currently probable that the employee will terminate (and the call right exercised) within 6 months of vesting, it is acceptable to classify the award as an equity instrument. In the event it becomes probable that the employee will terminate and the company will exercise the call within six months of vesting, the award would be reclassified as a liability, following the guidance for equity-to-liability modifications in ASC 718-20-55-144 (refer to SC 4.4.1). Note that this analysis may be different if the repurchase price was based on a formula that did not result in the holder bearing the risks and rewards of equity ownership, as the six-month holding period may not apply in that case.

3.3.4 Options settled in cash or other assets

An option or similar instrument that is required to be settled in cash or other assets is classified as a liability. For example, the awards in Example SC 3-1 (cash-settled SARs) are classified as liabilities because the awards will be settled in cash. A stock-settled SAR would be classified as equity (assuming the award meets all other requirements for equity classification). Similarly, a feature that allows an option to be net-share settled (i.e., shares are issued equal to the difference in value between the fair value of the shares and exercise price of the option on the exercise date) does not on its own cause the option to be classified as a liability.
If a company grants an award that offers a choice of settlement in stock or in cash (sometimes referred to as a tandem award), the classification of the award depends on whether the employee or the company has the choice of the form of settlement. If the employee can choose the form of settlement and can potentially require the company to settle the award in cash, the award should be classified as a liability. If the company has the choice of settlement, it can avoid transferring assets by electing to issue stock. In that case, as long as the company has the ability to deliver shares (i.e., sufficient authorized shares) the award would be classified as equity. ASC 718-10-25-15(a) clarifies that when assessing the company’s ability to deliver shares, a requirement to deliver registered shares should not, on its own, result in liability classification of the award.
The written terms of a stock-based compensation award are generally the best evidence to indicate that the award is a liability. However, a company's past practice of settlement may outweigh the written terms, resulting in a conclusion that an award that in form appears to be equity is, in substance a liability. For example, if a company's past practice has been to settle options in cash or it settles in cash whenever an employee asks for cash settlement, this would likely indicate that the options are in substance liabilities, even when the company retains the choice of settling the option in shares.
Additionally, when considering the company's ability to settle in shares, the company should consider the amount of shares currently authorized and available for issuance in its stock option plan. The number of shares that the company needs to have available for issuance may depend on whether it has the ability to settle stock options on a net basis (i.e., net of the exercise price). If the company does not have sufficient shares authorized and available for issuance to settle its outstanding awards, the amount that the company could not settle in shares should be accounted for as a liability.
Example SC 3-6 and Example SC 3-7 illustrate the considerations in evaluating a company's ability to deliver shares.
EXAMPLE SC 3-6
Grant of more than the current number of authorized shares
SC Corporation currently has one million shares authorized and unissued for its stock option plan. If additional authorized shares were needed to settle stock compensation awards, shareholder approval would be required.
SC Corporation granted two million at-the-money stock options on January 1, 20X1, which under the terms of the option plan, may be settled in any of the following ways at SC Corporation’s election:
  • Gross settlement—by physical delivery of two million shares in exchange for the aggregate exercise price
  • Net-share settlement— delivery of shares with a value equal to the difference between the market price at the date of exercise and the exercise price
  • Net-cash settlement— delivery of cash equal to the difference between the market price at the date of exercise and the exercise price
As SC Corporation does not have a sufficient number of authorized shares to satisfy the gross settlement alternative, should some or all of the award be classified as a liability?
Analysis
Not necessarily. The analysis will depend on SC Corporation's intent. In this scenario, although SC Corporation may not currently have the ability to deliver shares to satisfy gross settlement of all of the options, the terms of the plan permit net share settlement at SC Corporation's election. Thus, we believe it would be appropriate to determine whether SC Corporation intends to settle the awards net and if sufficient shares are authorized to satisfy net settlement.
If at some point the number of shares needed to net share settle the award exceeds the total shares authorized, the incremental portion would be accounted for as a liability, as the only other alternative is to cash settle the award. In that circumstance, equity to liability modification accounting should be applied; refer to SC 4.4.1.
EXAMPLE SC 3-7
Grant of awards subject to shareholder approval
SC Corporation grants awards to employees. In order for SC Corporation to settle the awards in equity, SC Corporation's shareholders must annually approve the release of the appropriate number of shares to satisfy the equity settlement. Although this generally occurs on or near the vesting date of the awards, management and the Board do not control enough votes to ensure this outcome. In the absence of shareholder approval, SC Corporation would be obligated to deliver cash to settle the awards.
On the grant date, does SC Corporation have the ability to deliver shares to support equity classification?
Analysis
No. In this fact pattern, SC Corporation's ability to deliver shares to satisfy the equity settlement is contingent upon shareholder approval; accordingly, SC Corporation would not be able to support equity classification on the grant date. Therefore, on the grant date, SC Corporation would classify the awards as liabilities until such time as they have the ability to deliver shares (in this case, upon shareholder approval).

3.3.4.1 Options with contingent cash settlement features

A stock option or award that has a cash settlement feature only upon the occurrence of a contingent event does not result in liability classification under ASC 718-10-25-11 if the contingent event is (1) not probable and (2) outside the control of the employee. For example, if an employee could force the company to settle stock options in cash upon a change in control, this feature would not result in liability accounting until the change in control event becomes probable. Generally, a change in control event is not considered probable until it occurs.
The probability of the contingent event occurring should be reassessed each reporting period. If the contingent event becomes probable, the stock option should be classified as a liability, and the change in classification should be accounted for as a modification from an equity award to a liability award (see guidance in SC 4.4).
SEC registrants should also consider whether the classification of awards with contingent cash settlement features as temporary equity is appropriate. See SC 3.3.10 for further guidance.

3.3.4.2 Awards settled partially in cash and partially in equity

Certain awards may be structured such that a portion of the award will be settled in equity and a portion will be settled in cash. Generally, it is appropriate to account for each part of the award separately.
An example of an award that is settled partially in cash and partially in equity is an option that includes a cash bonus feature designed to reimburse the employee for a portion of his or her personal income tax liability related to the exercise of the options. In this particular fact pattern, it would generally be appropriate to account for the option and the cash bonus as separate awards. The option would be equity-classified, assuming all other requirements for equity classification are met. The cash bonus is within the scope of ASC 718 because the amount of the bonus is based on changes in the company's stock price; therefore, the cash bonus should be accounted for at fair value and classified as a liability, similar to a cash-settled SAR.
Example SC 3-8 illustrates the accounting for a combination award with a guaranteed minimum value.
EXAMPLE  SC 3-8
Grant of awards with a guaranteed minimum value
SC Corporation grants an award of nonvested shares that cliff vest in five years. The award is structured, such that if the value of the shares does not exceed $1 million, cash will be paid for the difference between the value of the shares and $1 million on the date the award vests. In other words, the holder of the shares is guaranteed to receive at least $1 million in value at the date of vesting.
For example, if at vesting the shares have a value of $700,000, the holder would also receive $300,000 in cash. However, if at vesting the shares have a value of $1.2 million, the holder will receive no cash.
How should SC Corporation account for this award?
Analysis
This arrangement is effectively a share grant and a written put. The award should be considered a "combination award," as defined in ASC 718-10-20, and accounted for in a manner similar to Example 7 in ASC 718-10-55-116 through ASC 718-10-55-130.
The share component should be accounted for as an equity-classified award measured at grant-date fair value, and the cash-settled put should be liability classified and marked to fair value each reporting period. Compensation cost for the shares is fixed on the date of grant and recognized over the vesting period. Compensation cost associated with the cash-settled put liability should be recognized over the vesting period based on the remeasured fair value at each reporting period until settlement.

3.3.5 Options with underlying shares classified as liabilities

Options or similar instruments are also classified as liabilities when the underlying shares would be classified as liabilities. Therefore, if the shares underlying an option have repurchase features, a company should first consider whether the underlying shares would be classified as liabilities. For example, a public company may grant an option that it would settle by issuing a mandatorily redeemable share that is not subject to the scope exception in ASC 480. Because the underlying shares would be classified as a liability, options on those shares would also be classified as a liability in accordance with ASC 718.

3.3.6 Tax withholding on stock awards

A stock-based compensation plan may permit shares that would otherwise be issued upon an employee's exercise of an option or vesting of a restricted stock award to be "withheld" as a means of meeting the employer's tax withholding requirements for the income the employee will be deemed to have earned in the period of exercise/vesting. This is effectively an immediate repurchase of the withheld shares for cash; however, instead of remitting cash to the employee, the employer remits the cash to the taxing authority on behalf of employee.
Ordinarily, an immediate repurchase of shares would result in liability classification of an award. However, ASC 718-10-25-18 permits continued equity classification when shares are withheld for this purpose as long as (a) the employer has a statutory obligation to withhold taxes on the employee's behalf and (b) the amount withheld does not exceed the maximum statutory tax rates in the employee's applicable jurisdictions. If those requirements are not met, the entire award would be classified as a liability, not just the amount withheld for tax purposes. This assessment should be done on a jurisdiction-by-jurisdiction basis rather than using a "blended" rate across jurisdictions for all employees. If a company used a blended rate, then in those jurisdictions in which that rate exceeds the maximum statutory tax rate, the associated awards would be classified as a liability.
For jurisdictions that do not have any withholding requirement (certain non-US jurisdictions), or recipients for which no withholding is required (which could apply to non-executive members of the board of directors in the US), any withholding will cause the award to be liability-classified. Additionally, the employee cannot have the ability to require the employer to withhold more than the allowable amount. The maximum statutory tax rates are based on the applicable rates of the relevant tax authorities, including federal, state, and local authorities, including the employee’s share of payroll or similar taxes.
We believe that a company's convention of rounding up shares to the next whole share for purposes of meeting the net share settlement requirements does not alter equity classification if the convention is applied consistently and is not significant in relation to the withheld amount. For example, if the stock price per share is unusually high, the cash payment for the fractional share may substantively reflect a cash settlement of the award.
There are further complexities associated with employees who move from one jurisdiction to another ("mobile" employees). For these employees, companies will need to carefully assess the withholding requirements in each jurisdiction to determine the amount that represents the maximum statutory tax rate.

3.3.7 Awards exercised through broker-assisted cashless exercise

Many public companies offer their employees broker-assisted cashless exercise programs to help the employees exercise their stock options without having to use their personal funds to pay for the exercise price. A broker-assisted cashless exercise is the simultaneous exercise of a stock option by an employee and a sale of the shares through a broker.
A broker-assisted cashless exercise generally occurs as follows:
  • The employee exercises the stock option and authorizes the immediate sale of the shares that result from the option's exercise. On the same day that the option is exercised, the company notifies the broker of the sale order.
  • The broker executes the sale and notifies the company of the sales price.
  • By the settlement date (typically three days later), the company delivers the stock certificates to the broker.
  • On the settlement date, the broker (a) pays the company the exercise price plus the withholding taxes and (b) remits the net of the sales proceeds less the withholding taxes to the employee.
A broker-assisted cashless exercise of an employee stock option does not result in liability classification for the award if both of the following criteria in ASC 718-10-25-16 through ASC 718-10-25-17 are satisfied:
  • The cashless exercise requires an exercise of the stock options.
  • The company concludes that the employee is the legal owner of all the shares that are subject to the option (even though the employee did not pay the exercise price before the sale of the shares that are subject to the option).
Employees can sell shares from the exercise of options or vesting of restricted stock through a broker into the market and remit proceeds from the sale to the company in an amount that exceeds the amount permitted to be withheld for tax purposes without causing the award to become classified as a liability (see SC 3.3.6). In this situation, the company has not cash settled the awards; rather the company has delivered shares to settle the award and the employee has sold those shares in the market and remitted cash back to the company to settle the tax liability.

3.3.8  Award with exercise prices denominated in other currencies

ASC 718 requires that an award that is indexed to a factor that is not a market, performance, or service condition, should be classified as a liability (refer to SC 3.3.1). However, ASC 718-10-25-14 provides an exception to allow equity classification of certain awards with an exercise price denominated in currencies other than the currency in which the shares trade. This exception would apply to a company that grants an award to its employees resident in foreign jurisdictions with an exercise price that is denominated in either (1) the functional currency of the company's foreign operation; (2) the currency in which the employee is paid; or (3) the currency of a market in which a substantial portion of the entity's equity securities trades. If one of these exceptions is met, then the award would not be considered dual-indexed for purposes of ASC 718 and equity classification would be appropriate, assuming all other criteria for equity classification were met.

3.3.9 Repurchase features that function as forfeiture provisions

In some instances, companies grant awards to employees that are exercisable at the grant date, but contain a repurchase feature that enables the company to reacquire the shares for an amount equal to the original exercise price (or the lower of the current fair value and the original exercise price) if the employee terminates employment within a specified time period. The purpose of the repurchase feature is often to permit the employee to “early exercise” an option so that the employee’s holding period for the underlying stock begins at an earlier date to achieve a more favorable tax position.
The repurchase feature described above may be equivalent to a forfeiture provision and would not automatically be analyzed as a call right. This feature would not, on its own, require liability classification of the award. However, the repurchase feature creates an in-substance service period because the employer can repurchase the shares at the original purchase price if the employee terminates within the specified time period. Therefore, the requisite service period for such an award would include the period until the repurchase feature expires. The “early exercise” of an option during this period would not be considered substantive for accounting purposes and any cash received upon “early exercise” would be recognized as a deposit liability. Companies should assess the terms of an award and the surrounding facts and circumstances when determining whether a repurchase feature such as the one described above represents a forfeiture provision.

3.3.10  Temporary equity classification of redeemable securities

SEC registrants should also consider the requirements of SEC Accounting Series Release No. 268, Presentation in Financial Statements of “Redeemable Preferred Stocks,” (“ASR 268”) when determining the appropriate classification of an award. The SEC staff clarified in SAB Topic 14E (codified in ASC 718-10-S99-1) that ASR 268 (codified in ASC 480-10-S99-1) and related guidance (including ASC 480-10-S99-3A) are applicable to stock-based compensation. Under this guidance, SEC registrants with outstanding equity instruments that are redeemable (1) at a fixed or determinable price on a fixed or determinable date, (2) at the option of the holder, or (3) upon the occurrence of an event that is not solely within the control of the issuer are required to classify these securities outside of permanent equity (i.e., as temporary equity in the mezzanine section of the balance sheet).
Although non-SEC registrants (i.e., nonpublic companies) are not explicitly subject to the requirements of ASC 480-10-S99-1 and ASC 480-10-S99-3A, we believe the most appropriate classification for these types of instruments for all entities is outside of the equity section.
Certain awards that qualify for equity classification under ASC 718 may require classification as temporary equity under ASC 480-10-S99-3A, including:
  • Shares that are redeemable at the employee's discretion after a six month holding period or based on contingent events.
  • Options with underlying shares that are redeemable at the employee's discretion after a six month holding period or based on contingent events.
  • Options with cash settlement features based on contingent events.
SAB Topic 14E clarifies that companies should present as temporary equity an amount that is based on the redemption amount of the instrument, but takes into account the portion of the award that is vested. The redemption amount would differ if an award is an option (which generally requires an exercise price) compared to a restricted share (which generally has no exercise price). Intrinsic value is the redemption amount of an option because when an option is settled, the holder receives the difference between the fair value of the underlying shares and the exercise price of the option. If the shares underlying an option are redeemable, the holder pays the exercise price upon exercise of the option and then, upon redemption of the underlying shares, the holder receives the fair value of those shares. The net cash to the holder from the award, in either scenario, equals the stock option's intrinsic value. For a restricted stock award, the redemption amount is fair value, which is generally equal to intrinsic value because restricted stock does not have an exercise price.
Awards that are subject to the classification requirements of ASC 480-10-S99-3A should be presented as follows on the grant date:
  • Shares: Begin presenting the grant-date fair value of the share as temporary equity based on the portion of the vesting period that has passed. If the share is unvested on the grant date, then no amount is presented as temporary equity on the grant date.
  • Options: Begin presenting the grant-date intrinsic value of the option as temporary equity based on the portion of the vesting period that has passed. If the option is unvested on the grant date, then no amount is presented as temporary equity on the grant date.
Under ASC 480-10-S99-3A, if the award is not redeemable currently (e.g., because a contingency has not been met), and it is not probable that the award will become redeemable, adjusting the amount recognized in temporary equity is not required until it becomes probable that the award will become redeemable. However, for such awards that are unvested on the grant date, the redemption amount of the award as of the grant date (i.e., intrinsic value for options and fair value for restricted stock) should be reclassified to temporary equity over the requisite service period as the award vests. After the award is vested, the amount presented as temporary equity should be equal to the redemption amount of the award as of the grant date. For options that are granted at-the-money (no intrinsic value on the grant date), no amount will be presented as temporary equity as long as it is not probable that the option or underlying shares will become redeemable.
Once it becomes probable that the share or option will be redeemed, ASC 718 may require liability classification of the award. For example, shares and options with redemption features based on contingent events could be classified as equity under ASC 718 if the contingent event is not probable of occurring. Once the occurrence of the contingent event becomes probable, the award generally becomes a liability and, therefore, ASC 480-10-S99-3A is no longer applicable.
If the award is redeemable currently or it is probable that the award will become redeemable and the award would still be equity-classified under ASC 718 (e.g., a share that is redeemable at the employee's discretion after a six-month holding period), the redemption amount presented as temporary equity should be adjusted at each reporting date by reclassifying the change in the award's redemption amount from permanent equity to temporary equity without consideration of the amount of compensation cost previously recognized in equity. For example:
  • If a restricted stock award that qualifies for equity classification under ASC 718 is redeemable at fair value more than six months after vesting, and the restricted stock is 75% of the way through the vesting period at the balance sheet date, 75% of the current fair value of the stock at the balance sheet date should be presented as temporary equity. The redemption amount presented as temporary equity for restricted stock, which is based on the current fair value at each reporting period, generally will not be equal to the grant-date fair value that is recorded to APIC over the requisite service period.
  • If a redeemable option (or an option on redeemable stock) that qualifies for equity classification under ASC 718 is 75% of the way through the vesting period at the balance sheet date, 75% of the current intrinsic value of the option at the balance sheet date should be presented as temporary equity. The redemption amount presented as temporary equity for an option, which is based on the current intrinsic value at each reporting period, generally will not be equal to the grant-date fair value that is recorded to APIC over the requisite service period.
Figure SC 3-2 summarizes the amounts that should be presented as temporary equity for four different stock-based compensation awards. The examples assume that the awards meet the criteria for equity classification under ASC 718.
Figure SC 3-2
Impact of ASC 480-10-S99-3A on four different stock-based compensation awards
Award
Amount presented as temporary equity on the grant date
Subsequent adjustments to temporary equity
  • At-the-money option
  • Underlying shares are puttable at fair value by the employee after a six-month holding period
  • Option cliff vests in four years
  • Grant-date fair value is $50,000.
  • One year after grant, the intrinsic value is $100,000.
No amount is presented as temporary equity on the grant date because the option is unvested and has no grant-date intrinsic value.
Because it is probable that the underlying shares will become redeemable, the company should present the current intrinsic value at each reporting date as temporary equity as the option vests.
At the end of the first year, 25% of the intrinsic value, or $25,000, would be reclassified from permanent equity to temporary equity even though only $12,500 (25% of the option's grant-date fair value) has been credited to equity as compensation cost.
  • At-the-money option
  • Cash settlement feature that permits the employee to put the option to the company at fair value upon a change in control.
  • Option cliff vests in four years.
  • Grant-date fair value is $50,000
  • One year after grant, the intrinsic value is $100,000.
No amount is presented as temporary equity on the grant date because the option is unvested and has no grant-date intrinsic value.
The company will not present any amount as temporary equity until the change in control occurs, because the option had no intrinsic value on the grant date and it is not probable that the option will become redeemable. If it becomes probable that the options will be cash settled (i.e., the change in control occurs), the award would become a liability (accounted for as an equity-to-liability modification).
  • In-the-money option
  • Intrinsic value of $30,000 on the grant date
  • Underlying shares are puttable at fair value by the employee after a six-month holding period.
  • 100% vested on the grant date.
  • Grant-date fair value is $50,000.
  • One year after grant, the intrinsic value is $100,000.
The intrinsic value of the option, or $30,000, is presented as temporary equity on the grant date because the option is vested and was granted in-the-money.
Because it is probable that the underlying shares will become redeemable, the company should continue to adjust the amount presented as temporary equity to the current intrinsic value at each reporting date.
At the end of the first year, an additional $70,000 would be reclassified from permanent equity to temporary equity, for a cumulative total of $100,000 presented as temporary equity, even though only $50,000 was credited to equity as compensation cost at the grant date fair value.
  • Restricted stock
  • Cliff vests in four years.
  • Immediately vests and becomes puttable at fair value by the employee upon a change in control.
  • Grant-date fair value is $150,000
  • One year after grant, the fair value is $200,000.
No amount is presented as temporary equity on the grant date because the restricted stock is unvested.
Over the vesting period, the company should present the grant-date fair value as temporary equity.
At the end of the first year, 25% of the grant-date fair value, or $37,500, would be reclassified from permanent equity to temporary equity.
Because it is not probable that the stock will become redeemable (change in control is not probable until it occurs), the company should not adjust the amount presented as temporary equity to the current intrinsic value (redemption amount, which also happens to be the fair value of the shares) at each reporting date.
If a change in control becomes probable and the put becomes active within six months of vesting, the award would become a liability under ASC 718 (accounted for as an equity-to-liability modification).
If a change in control becomes probable more than six months after the vesting date of the stock, the company should adjust the amount presented in temporary equity to the current fair value in each subsequent period as long as the put is active.
Application of the guidance in ASC 480-10-S99-3A does not affect the amount or timing of recognition of compensation cost in the financial statements. Rather, application of this guidance could result in the reclassification of amounts from permanent equity to temporary equity to highlight the company’s redemption obligations. Additionally, as long as the redemption amount is at fair value (or for an option, the market price of the stock less the exercise price of the option), we believe that the redemption right does not represent a preferential distribution under ASC 480-10-S99-3A, and, therefore, the company would not be required to apply the two-class method of calculating earnings per share described in ASC 260-10-45-60B.

3.3.11  Liability or equity classification criteria for awards

Figure SC 3-3 and Figure SC 3-4 summarize the basic criteria for determining the appropriate classification of a share award and a stock option, respectively. These flowcharts may not address the appropriate classification of awards with complex or unusual terms.
Figure SC 3-3
Liability and equity classification of a share award
View image
* Companies should also apply the classification and measurement provisions of ASC 480-10-S99-1 and ASC 480-10-S99-3A, which may require classification of certain amounts outside of permanent equity.
Figure SC 3-4
Liability and equity classification of a stock option
View image
* Companies should also apply the classification and measurement provisions of ASC 480-10-S99-1 and ASC 480-10-S99-3A, which may require classification of certain amounts outside of permanent equity.
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