The core model
Equity-classified share-based payments are measured at grant-date fair value and recognized as compensation expense over the requisite service period (usually the vesting period). The grant-date measurement is not revisited for later changes in the share price.
EXAMPLE: On January 1, a company grants options with a total grant-date fair value of $600,000, vesting over three years. Compensation expense is $200,000 per year (Dr. Compensation expense / Cr. APIC — Stock options), regardless of whether the stock price doubles or collapses in the meantime.
Equity-classified vs. liability-classified
| Equity-classified | Liability-classified | |
|---|---|---|
| Examples | Stock options, restricted stock settled in shares | Cash-settled SARs, awards with certain repurchase features |
| Measurement | Grant-date fair value, fixed | Remeasured to fair value each reporting period until settlement |
Vesting conditions
- Service condition — recognize over the service period
- Performance condition (e.g., achieving an earnings target) — recognize expense only if achievement is probable; reverse if it becomes improbable
- Market condition (e.g., share price target) — factored into the grant-date fair value. Expense is not reversed even if the market condition is never met, provided service is rendered
IMPORTANT: The market condition asymmetry is a favorite exam point. Fail a performance condition → reverse the expense. Fail a market condition → keep the expense, because the probability was already priced into the grant-date fair value.
Forfeitures and modifications
- An entity may elect to estimate forfeitures or account for them as they occur.
- A modification is treated as an exchange: recognize incremental fair value (modified fair value minus original fair value immediately before modification) in addition to remaining unrecognized original cost.
EXAM TIP: For an employee, exercising an incentive stock option (ISO) creates no regular taxable income but does create an AMT adjustment — connecting this BAR topic to REG/TCP.