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Entities awarding shared-based payments to nonemployees should consider guidance in addition to ASC 505-50

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Accounting for share-based payment awards issued to nonemployees
Entities often grant share-based payment awards to nonemployees, such as suppliers, service providers, and independent contractors. The guidance in ASC 505-50, Equity: Equity-Based Payments to Non-Employees, applies generally to nonemployee share-based payment awards (excluding equity instruments issued to a lender or investor who provides financing to the issuer or those issued in a business combination), but it does not address all aspects of accounting for these awards. Entities that grant share-based payment awards to nonemployees must refer to other guidance, such as ASC 718, Compensation: Stock Compensation, to address the accounting requirements that are not considered in ASC 505-50.

Measurement
ASC 505-50 states that the measurement basis for nonemployee awards is the more reliably measurable fair value of either the awards or the goods or services received in exchange for the awards. The measurement date, as defined in ASC 505-50, determines when the fair value is “fixed” and when the total amount of consideration exchanged in the arrangement is therefore known.

According to ASC 505-50-30-11, the measurement date is the earlier of when a performance commitment exists or performance is complete. A performance commitment exists when the counterparty’s performance is deemed probable because there is a significant disincentive for nonperformance. Neither forfeiture of the awards nor the ability to sue for nonperformance constitutes a sufficiently large disincentive to indicate that performance is probable. Generally, we believe that a performance commitment exists only if the arrangement includes a significant financial penalty for nonperformance.

Unlike many employee share-based payment awards, nonemployee awards often do not contain restrictions on the holder’s ability to transfer and to hedge the award, and they might not stipulate that the contractual term of the award is truncated when service is terminated post-vesting. Therefore, to measure the fair value of nonemployee awards, an entity should generally incorporate the contractual term rather than the expected term into the fair value measurement. This methodology is in contrast to the measurement of employee share-based payment awards, which generally incorporates the expected term.

Although under ASC 718, certain nonpublic companies have the option to account for employee awards using a calculated value instead of fair value, we do not believe that option can be applied to nonemployee awards.

Classification ASC 505-50 does not address the classification of nonemployee awards. Therefore, entities generally refer to the classification guidance in ASC 718 to determine whether a nonemployee award is classified as a liability or a component of equity.

It is important to note that the classification determination has a lesser accounting impact for nonemployee awards than employee awards. Employee awards that are classified as equity are measured at the grant-date fair value and are not subsequently remeasured, whereas employee awards that are classified as liabilities must be remeasured at fair value on each reporting date. In contrast, nonemployee awards are measured at fair value on the measurement date, which might not occur until performance is complete, regardless of whether the award is classified as a liability or a component of equity. As a result, if an entity must recognize a portion of the cost of an equity-classified nonemployee award before its measurement date, the amount recognized would be impacted by remeasurements until the measurement date is reached.

Recognition
The fair value of a nonemployee award must be recognized in the same period(s) and in the same manner as though the entity had paid cash for the goods or services. Therefore, an entity might be required to recognize a portion of the fair value of a nonemployee award before it reaches the measurement date.

If the quantity and terms of a nonemployee award are known up front, then the portion of the award’s fair value at each reporting date must be recognized based on the applicable guidance as though the entity had paid cash for the goods or services.

If the quantity and terms of a nonemployee award are not known initially, then the entity must determine whether market conditions, counterparty performance conditions, or both, impact the quantity and terms.

A market condition relates to either (1) a specified share price or a specified intrinsic value indexed solely to the entity’s stock or (2) a specified share price in terms of a similar, or an index of similar, equity security or securities.

A counterparty performance condition relates to the achievement of a specified performance target that pertains to the performance of the entity as a whole or to the performance of a part of the entity. A counterparty performance condition is generally viewed similarly to a performance condition, as defined in ASC 718.

If the quantity and terms of a nonemployee award are impacted only by a market condition, then an entity must recognize the cost in the same manner as though the quantity and terms were fixed up front. That is, the entity would remeasure the award’s fair value each reporting period and recognize the appropriate amount based on the applicable guidance as though the entity had paid cash for the goods or services.

If the quantity and terms are impacted only by a counterparty performance condition, then the entity must measure the awards at the then-current lowest aggregate fair value at each reporting date. The lowest aggregate fair value refers to the lower end of the range of possible values of the awards, depending on whether the counterparty performance condition is satisfied or not. Because this amount could be zero, it is possible that an entity would not recognize any cost prior to the measurement date for a nonemployee award that lacks a performance commitment if the holder would forfeit the award because performance is not completed.

If the quantity and terms are impacted by both a market condition and a counterparty performance condition, then the entity would follow the recognition guidance for awards that contain only a counterparty performance condition.

Example 1
Entity A issues restricted stock units (RSUs) to Entity B in exchange for asset management services. In order for the awards to become unrestricted, Entity A must earn a return on assets equal to or in excess of 10 percent during the one-year period following the issuance date. If Entity A’s return on assets is less than 10 percent over that period, then Entity B would forfeit its RSUs. If Entity B ceases providing asset management services to Entity A at any time during the one-year period following the issuance date, it would also forfeit the RSUs.

The RSUs are nonemployee share-based payment awards under ASC 505-50. Since there is no significant disincentive for nonperformance (Entity B merely forfeits the RSUs), the measurement date would not occur until performance is complete. Performance is complete once Entity B has provided asset management services to Entity A for the one-year period following the issuance date.

If Entity A paid cash to Entity B in exchange for the asset management services, it would recognize the cost of those services as they are performed over the one-year period following the issuance date. However, the quantity and terms of the RSUs depend on a counterparty performance condition; therefore, Entity A would recognize the then-current lowest aggregate fair value of the awards at each reporting date preceding the measurement date.

If Entity A issued the RSUs on January 1, 2013, the lowest aggregate fair value of the awards on March 31, 2013 would be zero because it is possible that Entity A’s return on assets could be lower than 10 percent for the period from January 1 to December 31, 2013. Therefore, as of March 31, 2013, Entity A would not recognize any expense associated with the RSUs issued to Entity B.

If it is later determined that Entity A earned a return on assets of 12 percent for the year ended December 31, 2013, then it would recognize the fair value of the RSUs on December 31, 2013 as an expense in its fourth-quarter 2013 statement of comprehensive income.

Example 2
Entity C issues restricted stock units (RSUs) to Entity D in exchange for asset management services. In order for all the awards to become unrestricted, Entity C’s stock price must increase by at least 10 percent over the one-year period following the issuance date. If Entity D ceases providing asset management services to Entity C at any time during the one-year period following the issuance date, it will forfeit the RSUs.

The RSUs are nonemployee share-based payment awards under ASC 505-50. Since there is no significant disincentive for nonperformance (Entity D merely forfeits the RSUs), the measurement date would not occur until performance is complete. Performance is complete once Entity D has provided asset management services to Entity C for the one-year period following the issuance date.

If Entity C paid cash to Entity D in exchange for the asset management services, it would recognize the cost of those services as they are performed over the one-year period following the issuance date. The quantity and terms of the RSUs depend on a market condition; therefore, Entity C would recognize the fair value of the awards as though the quantity and terms were known up front. If Entity C issued the RSUs on January 1, 2013 and if the fair value of the awards is $1 million on March 31, 2013, then Entity C would recognize $250,000 of expense for asset management services in its first-quarter 2013 statement of comprehensive income.

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