The cash settlement of an award (which could be a share, a stock option, or another share-based payment instrument) is the repurchase of an outstanding equity instrument. An equity-classified award that is settled in cash should be accounted for as follows (as per ASC 718-20-35-7):
  • If the award is unvested and probable of vesting, the company should recognize the cash settlement as the repurchase of an equity instrument concurrent with the acceleration of vesting of the award. Any unrecognized compensation cost based on the grant-date fair value of the award would be accelerated and recognized on the settlement date.
  • If the award (vested or unvested) is cash settled at its current fair value as of the settlement date, no incremental compensation cost should be recognized. If the award is cash-settled for an amount greater than its fair value, additional compensation cost for the difference should be recognized along with any remaining unrecognized compensation cost. If the award is settled for an amount less than its fair value, the entire amount of cash transferred to repurchase the award should be charged to equity and any remaining unrecognized compensation cost should be recognized.
  • If the award was not probable of vesting as of the cash settlement date, the fair value of the award immediately prior to the cash settlement is zero, and any amounts previously recognized as compensation cost would be reversed (or would have already been reversed). The entire amount paid to settle the award should be charged to compensation cost.

It is important to distinguish between an award that has been repurchased or settled and an award that has been modified to change its classification to a liability. If the award has been modified, the modification is accounted for following the approach described in SC 4.4.1, which could have a significantly different accounting impact.
The repurchase of an award that is an infrequent transaction, negotiated after the award is granted, and not pursuant to a pre-existing right of the company, is generally accounted for as a repurchase of equity in accordance with ASC 718-20-35-7. However, a history of cash settlements may indicate that the substantive terms of outstanding awards include a cash settlement feature, which could result in liability classification of those awards. Refer to SC 3 for additional information.
If a company has a pre-existing right to settle an award in cash and had previously intended to settle it in equity (or a pre-existing call right that it did not previously intend to exercise prior to the holder bearing the risks and rewards of equity ownership for at least six months) but subsequently changes its intention, then, even absent any change to the terms of award, the award is considered to have been modified to a liability-classified award and the accounting described in SC 4.4.1 would apply. Another example of an award that has been modified is an equity award that is converted to a fixed cash payment that is earned over a future service period. ASC 718-20-55-144 provides an example of this type of modification.

4.8.1 Repurchase of stock held by an employee

When a company (or a related party or other holder of an economic interest) repurchases stock held by employees, it is important to consider the accounting requirements in ASC 718-20-35-7. This guidance indicates that any excess of repurchase price over the fair value of the instrument repurchased should be recognized as compensation cost.
We believe the repurchase guidance in ASC 718 should generally be applied even if the shares repurchased from employees are vested and were not originally issued as compensation (e.g., founder's stock). In some fact patterns, judgment may be required to determine whether the repurchase of stock results in compensation expense, including whether the price paid is greater than fair value.
We believe this guidance should generally be applied in the same way to shares repurchased from former employees. However, in some cases, judgment may be needed to determine if the repurchase from former employees may be considered non-compensatory (not related to past service, but solely in their capacity as a shareholder). Factors to consider include: the makeup of the shareholders that were offered the opportunity to participate in the repurchase (for example, primarily employees versus a significant proportion of nonemployee shareholders), the length of time since the former employee was employed, as well as other aspects of the overall transaction.

4.8.2 Sale of employee stock in the secondary market

The market for private company equity securities, often referred to as the "secondary market," continues to expand. Sales of employee shares to a third party in a secondary market transaction can introduce unique accounting challenges.
A purchase by a third party of shares from an employee or former employee, at fair value, is typically a transaction among shareholders, with no accounting recognition by the company. However, if the transaction price paid by the third party exceeds the fair value of the shares, the company will need to evaluate whether there is a compensatory element to the arrangement. In particular, if the company is involved in facilitating the transaction, it is likely that compensation expense will arise. Consideration of the extent of the company's involvement should include whether the company helped to arrange the transaction and whether it was concurrent with (or a condition for) a sale of other financial instruments by the company to the third party.
It is also important to understand the relationship between the company and the third party in the transaction. If the third party has a pre-existing economic interest in the company, the third party is presumed to be acting on behalf of the company as described in SC 1.4, and any excess of the purchase price over the fair value of the equity interest would be considered compensation to the employees for their services, unless the payment is clearly made for another economic benefit that the third party receives. The company would reflect the transaction as a contribution of the excess purchase price from the economic interest holder and payment of compensation to the employee or former employee. However, if the third party has only a de minimis ownership interest it may be reasonable to conclude that the buyer is acting independently rather than on behalf of the entity, and any excess of the purchase price of the shares or other equity instruments from the employee over their fair value may not be considered compensatory.
Secondary market transactions may also impact the classification of equity instruments or other share-based payment awards held by employees. As discussed in SC 3.3.3, a company’s history of repurchasing unexercised options or “immature” shares (shares in which the employee has not yet vested or has vested but which have been held for less than six months) could create a presumption that the company intends to settle future awards in cash, which would require liability classification for those awards. Whether a similar conclusion would apply to repurchases of equity instruments held by employees in secondary market transactions would depend on the relationship of the purchaser to the company and the underlying facts and circumstances of the repurchase transactions. We believe that secondary market repurchases by an outside investor would typically not create an in-substance liability arrangement, as the company is not using its own funds to settle the arrangement. In addition, absent other circumstances that indicate the company has arranged for the systematic or recurring repurchase by the same third-party investor of equity instruments held by its employees, typically these transactions would not be considered when determining whether the company has established a past practice of settling immature shares. However, it is important to consider the level of ownership of the economic interest holder. If, for example, the purchaser is a shareholder who holds all or the vast majority of the company’s equity, the substance of the repurchase may be that the economic interest holder is indifferent as to whether the company repurchases or the shareholder repurchases, and thus liability classification may be appropriate.
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