[Federal Register Volume 86, Number 228 (Wednesday, December 1, 2021)]
[Rules and Regulations]
[Pages 68111-68123]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2021-26027]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 211

[Release No. SAB 120]


Staff Accounting Bulletin No. 120

AGENCY: Securities and Exchange Commission.

ACTION: Publication of Staff Accounting Bulletin.

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SUMMARY: This staff accounting bulletin expresses the views of the 
staff regarding the estimation of the fair value of share-based payment 
transactions in accordance with Financial Accounting Standards Board 
(``FASB'') Accounting Standards Codification (``ASC'') Topic 718, 
Compensation--Stock Compensation (``Topic 718''), when a company is in 
possession of material non-public information, and modifies portions of 
the interpretive guidance included in the Staff Accounting Bulletin 
Series (``Series'') in order to make the relevant interpretive guidance 
consistent with current authoritative accounting guidance, 
specifically, to update the Series to bring existing guidance into 
conformity with Topic 718.

DATES: Effective December 1, 2021.

FOR FURTHER INFORMATION CONTACT: Dan Janiak, Professional Accounting 
Fellow, Office of the Chief Accountant at (202) 551-5300 or Todd E. 
Hardiman, Associate Chief Accountant, Division of Corporation Finance 
at (202) 551-3400, Securities and Exchange Commission, 100 F Street NE, 
Washington, DC 20549.

SUPPLEMENTARY INFORMATION: The statements in staff accounting bulletins 
are not rules or interpretations of the Commission, nor are they 
published as bearing the Commission's official approval. They represent 
interpretations and practices followed by the Division of Corporation 
Finance and the Office of the Chief Accountant in administering the 
disclosure requirements of the federal securities laws.

    Dated: November 24, 2021.
J. Matthew DeLesDernier,
Assistant Secretary.

PART 211--[AMENDED]

    Accordingly, Part 211 of Title 17 of the Code of Federal 
Regulations is amended as follows:

PART 211--INTERPRETATIONS RELATING TO FINANCIAL REPORTING MATTERS

0
1. The authority citation for 17 CFR 211 continues to read as follows:

    Authority:  15 U.S.C. 77g, 15 U.S.C. 77s(a), 15 U.S.C. 77aa(25) 
and (26), 15 U.S.C. 78c(b), 17 CFR 78l(b) and 13(b), 17 CFR 78m(b) 
and 15 U.S.C. 80a-8, 30(e) 15 U.S.C. 80a-29(e), 15 U.S.C. 80a-30, 
and 15 U.S.C. 80a-37(a).

0
2. Amend the table in subpart B by adding an entry for Staff Accounting 
Bulletin No. 120 at the end of the table to read as follows:

Subpart B--Staff Accounting Bulletins

[[Page 68112]]



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               Subject                       Release No.                  Date           Fed. Reg. Vol. and page
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                                                  * * * * * * *
Publication of Staff Accounting        SAB120.................  December 1, 2021.......  [Insert Federal
 Bulletin No. 120.                                                                        Register citation].
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    Note: The text of Staff Accounting Bulletin No. 120 will not 
appear in the Code of Federal Regulations.

Staff Accounting Bulletin No. 120

    This staff accounting bulletin (``SAB'') adds interpretive guidance 
for public companies to consider when entering into share-based payment 
transactions while in possession of material non-public information, 
including share-based payment transactions that are commonly referred 
to as being ``spring-loaded.'' Specifically, the staff is updating the 
Series to provide additional guidance to companies estimating the fair 
value of share-based payment transactions in accordance with Topic 718 
regarding the determination of the current price of the underlying 
share and the estimation of the expected volatility of the price of the 
underlying share for the expected term when the company is in 
possession of material non-public information.
    Additionally, this SAB rescinds portions and conforms portions of 
the interpretive guidance included in the Series in order to make the 
relevant staff interpretive guidance consistent with the latest U.S. 
generally accepted accounting principles (``U.S. GAAP'') as issued by 
the FASB. Specifically, the staff is updating the Series in order to 
bring existing guidance into conformity with Topic 718. The FASB has 
undertaken various projects to update share-based payment accounting in 
Topic 718 including, but not limited to, issuing:
     Accounting Standards Update (``ASU'') 2019-08, 
Compensation--Stock Compensation (Topic 718) and Revenue from Contracts 
with Customers (Topic 606): Codification Improvements--Share-Based 
Consideration Payable to a Customer, in November 2019;
     ASU 2018-07, Compensation--Stock Compensation (Topic 718): 
Improvements to Nonemployee Share-Based Payment Accounting (``ASU 2018-
07''), in June 2018; and
     ASU 2016-09, Compensation--Stock Compensation (Topic 718): 
Improvements to Employee Share-Based Payment Accounting (``ASU 2016-
09''), in March 2016.
    The rescissions and conforming changes bring existing guidance into 
conformity with Topic 718, as updated by these ASUs.
    The following describes the additional interpretive guidance, 
rescissions, and conforming edits made to the Series that are presented 
at the end of this release:

1. Topic 14: Share-Based Payment

    Topic 14 includes Securities and Exchange Commission staff views on 
a variety of share-based payment topics. This SAB makes the following 
updates to Topic 14:
    a. Amendment and replacement of Topic 14.D: Certain Assumptions 
Used in Valuation Methods. The staff has observed numerous instances 
where companies have granted share-based compensation while in 
possession of positive material non-public information, including 
share-based payment transactions that are commonly referred to as being 
``spring-loaded.'' When companies are in possession of positive 
material non-public information, the staff believes these companies 
should consider whether adjustments to the current price of the 
underlying share or the expected volatility of the price of the 
underlying share for the expected term of the share-based payment award 
are appropriate when applying a fair-value-based measurement method to 
estimate the cost of its share-based payment transactions. The staff is 
including examples where such adjustments may be necessary and is 
reminding companies of their corporate governance obligations and 
disclosure obligations under U.S. GAAP with respect to share-based 
payment transactions, as well as the need to maintain effective 
internal control over financial reporting.
    b. Rescission of Subtopic 14.A: Share-Based Payment Transactions 
with Nonemployees. The interpretive guidance included in this Subtopic 
addresses if share-based payment transactions with nonemployees are 
included in the scope of ASC 718. Because the amendments in ASU 2018-07 
expand the scope of ASC 718 to include accounting for share-based 
payment transactions with nonemployees and supersede the guidance in 
FASB ASC Subtopic 505-50, Equity: Equity-Based Payments to Non-
Employees (``ASC 505-50''), Topic 14.A is no longer relevant.
    c. Conforming edits to Subtopics 14.B: Transition from Nonpublic to 
Public Entity Status; 14.C: Valuation Methods; 14.D: Certain 
Assumptions Used in Valuation Methods; 14.E: FASB ASC Topic 718, 
Compensation--Stock Compensation, and Certain Redeemable Financial 
Instruments; 14.F: Classification of Compensation Expense Associated 
with Share-Based Payment Arrangements; and 14.I: Capitalization of 
Compensation Cost Related to Share-Based Payment Arrangements. Recent 
FASB ASUs 2018-07 and 2016-09 updated terminology used in ASC 718. 
Because the aforementioned Subtopics in Topic 14 directly or indirectly 
reference ASC 718, conforming updates are necessary to reflect the most 
updated U.S. GAAP terminology.

2. Topic 5: Miscellaneous Accounting

    Subtopic 5.T: Accounting for Expenses or Liabilities Paid by 
Principal Stockholder(s) is updated to make conforming edits as a 
result of amendments in ASU 2018-07. Subtopic 5.T references ASC 718-
10-15-4 and ASU 2018-07 updated the terminology used in this paragraph 
to include awards to both employees and nonemployees. The conforming 
updates are necessary to reflect the most updated U.S. GAAP 
terminology.
    Accordingly, the staff hereby amends the Staff Accounting Bulletin 
Series as follows:
* * * * *

Topic 14: Share-Based Payment

* * * * *
    The interpretations in this SAB express views of the staff 
regarding the interaction between FASB ASC Topic 718, Compensation--
Stock Compensation, and certain SEC rules and regulations and provide 
the staff's views regarding the valuation of share-based payment 
arrangements for public companies. FASB ASC Topic 718 is based on the 
underlying accounting principle that compensation cost resulting from 
share-based payment transactions be recognized in financial statements 
at fair value.\1\ Recognition of compensation cost at fair value will 
provide investors and other users of financial statements with more

[[Page 68113]]

complete and comparable financial information.
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    \1\ FASB ASC paragraphs 718-10-30-2 through 718-10-30-4.
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    FASB ASC Topic 718 addresses a wide range of share-based 
compensation arrangements including share options, restricted share 
plans, performance-based awards, share appreciation rights, and 
employee share purchase plans.
    FASB ASC Topic 718 replaced guidance originally issued in 1995 that 
established as preferable, but did not require, a fair-value-based 
method of accounting for share-based payment transactions with 
employees. It also replaced guidance originally issued in 1996 that 
provided different recognition and measurement requirements for share-
based payment awards granted to nonemployees than for those granted to 
employees.
    The staff believes the guidance in this SAB will assist issuers in 
their application of FASB ASC Topic 718 and enhance the information 
received by investors and other users of financial statements, thereby 
assisting them in making investment and other decisions. This SAB 
includes interpretive guidance related to the transition from nonpublic 
to public entity \2\ status, valuation methods (including assumptions 
such as expected volatility, expected term, and current price of the 
underlying share, particularly when valuing spring-loaded awards \3\), 
the accounting for certain redeemable financial instruments issued 
under share-based payment arrangements, the classification of 
compensation expense, and capitalization of compensation cost related 
to share-based payment arrangements.
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    \2\ Defined in the FASB ASC Master Glossary.
    \3\ A share-based payment award granted when a company is in 
possession of material nonpublic information to which the market is 
likely to react positively when the information is announced is 
sometimes referred to as being ``spring-loaded.'' The interpretive 
guidance included in this SAB with respect to spring-loaded share-
based payment awards is not limited to share options, and applies to 
all instruments including, for example, restricted stock units.
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    The staff recognizes that there is a range of conduct that a 
reasonable issuer might use to make estimates and valuations and 
otherwise apply FASB ASC Topic 718, and the interpretive guidance 
provided by this SAB. Thus, throughout this SAB the use of the terms 
``reasonable'' and ``reasonably'' is not meant to imply a single 
conclusion or methodology, but to encompass the full range of potential 
conduct, conclusions or methodologies upon which an issuer may 
reasonably base its valuation decisions. Different conduct, conclusions 
or methodologies by different issuers in a given situation does not of 
itself raise an inference that any of those issuers is acting 
unreasonably. While the zone of reasonable conduct is not unlimited, 
the staff expects that it will be rare, except when observable market 
prices of identical or similar equity or liability instruments in 
active markets are available, when there is only one acceptable choice 
in estimating the fair value of share-based payment arrangements under 
the provisions of FASB ASC Topic 718 and the interpretive guidance 
provided by this SAB in any given situation. In addition, as discussed 
in the Interpretive Response to Question 1 of Section C, Valuation 
Methods, estimates of fair value are not intended to predict actual 
future events, and subsequent events are not indicative of the 
reasonableness of the original estimates of fair value made under FASB 
ASC Topic 718.
* * * * *

A. Removed by SAB 120

B. Transition From Nonpublic to Public Entity Status

    Facts: Company A is a nonpublic entity \4\ that first files a 
registration statement with the SEC to register its equity securities 
for sale in a public market on January 2, 20X8. As a nonpublic entity, 
Company A had been assigning value to its share options \5\ under the 
calculated value method prescribed by FASB ASC Topic 718, 
Compensation--Stock Compensation,\6\ and had elected to measure its 
liability awards based on intrinsic value. Company A is considered a 
public entity on January 2, 20X8 when it makes its initial filing with 
the SEC in preparation for the sale of its shares in a public market.
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    \4\ Defined in the FASB ASC Master Glossary.
    \5\ For purposes of this staff accounting bulletin, the phrase 
``share options'' is used to refer to ``share options or similar 
instruments.''
    \6\ FASB ASC paragraph 718-10-30-20 requires a nonpublic entity 
to use the calculated value method when it is not able to reasonably 
estimate the fair value of its equity share options and similar 
instruments because it is not practicable for it to estimate the 
expected volatility of its share price. FASB ASC paragraph 718-10-
55-51 indicates that a nonpublic entity may be able to identify 
similar public entities for which share or option price information 
is available and may consider the historical, expected, or implied 
volatility of those entities' share prices in estimating expected 
volatility. The staff would expect an entity that becomes a public 
entity and had previously measured its share options under the 
calculated value method to be able to support its previous decision 
to use calculated value and to provide the disclosures required by 
FASB ASC subparagraph 718-10-50-2(f)(2)(ii).
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    Question 1: How should Company A account for the share options that 
were granted prior to January 2, 20X8 for which the requisite service 
has not been rendered by January 2, 20X8?
    Interpretive Response: Prior to becoming a public entity, Company A 
had been assigning value to its share options under the calculated 
value method. The staff believes that Company A should continue to 
follow that approach for those share options that were granted prior to 
January 2, 20X8, unless those share options are subsequently modified, 
repurchased or cancelled.\7\ If the share options are subsequently 
modified, repurchased or cancelled, Company A would assess the event 
under the public company provisions of FASB ASC Topic 718. For example, 
if Company A modified the share options on February 1, 20X8, any 
incremental compensation cost would be measured under FASB ASC 
subparagraph 718-20-35-3(a), as the fair value of the modified share 
options over the fair value of the original share options measured 
immediately before the terms were modified.\8\
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    \7\ This view is consistent with the FASB's basis for rejecting 
full retrospective application of FASB ASC Topic 718 as described in 
the basis for conclusions of Statement 123R, paragraph B251.
    \8\ FASB ASC paragraph 718-20-55-94. The staff believes that 
because Company A is a public entity as of the date of the 
modification, it would be inappropriate to use the calculated value 
method to measure the original share options immediately before the 
terms were modified.
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    Question 2: How should Company A account for its liability awards 
granted prior to January 2, 20X8 that are fully vested but have not 
been settled by January 2, 20X8?
    Interpretive Response: As a nonpublic entity, Company A had elected 
to measure its liability awards subject to FASB ASC Topic 718 at 
intrinsic value.\9\ When Company A becomes a public entity, it should 
measure the liability awards at their fair value determined in 
accordance with FASB ASC Topic 718.\10\ In that reporting period there 
will be an incremental amount of measured cost for the difference 
between fair value as determined under FASB ASC Topic 718 and intrinsic 
value. For example, assume the intrinsic value in the period ended 
December 31, 20X7 was $10 per award. At the end of the first reporting 
period ending after January 2, 20X8 (when Company A becomes a public 
entity), assume the intrinsic value of the award is $12 and the fair 
value as determined in accordance with FASB ASC Topic 718 is $15. The 
measured cost in the first reporting period after December 31, 20X7 
would be $5.\11\
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    \9\ FASB ASC paragraph 718-30-30-2.
    \10\ FASB ASC paragraph 718-30-35-3.
    \11\ $15 fair value less $10 intrinsic value equals $5 of 
incremental cost.
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    Question 3: After becoming a public entity, may Company A 
retrospectively

[[Page 68114]]

apply the fair-value-based method to its awards that were granted prior 
to the date Company A became a public entity?
    Interpretive Response: No. Before becoming a public entity, Company 
A did not use the fair-value-based method for either its share options 
or its liability awards. The staff does not believe it is appropriate 
for Company A to apply the fair-value-based method on a retrospective 
basis, because it would require the entity to make estimates of a prior 
period, which, due to hindsight, may vary significantly from estimates 
that would have been made contemporaneously in prior periods.\12\
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    \12\ This view is consistent with the FASB's basis for rejecting 
full retrospective application of FASB ASC Topic 718 as described in 
the basis for conclusions of Statement 123R, paragraph B251.
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    Question 4: Upon becoming a public entity, what disclosures should 
Company A consider in addition to those prescribed by FASB ASC Topic 
718? \13\
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    \13\ FASB ASC Section 718-10-50.
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    Interpretive Response: In the registration statement filed on 
January 2, 20X8, Company A should clearly describe in MD&A the change 
in accounting policy that will be required by FASB ASC Topic 718 in 
subsequent periods and the reasonably likely material future 
effects.\14\ In subsequent filings, Company A should provide financial 
statement disclosure of the effects of the changes in accounting 
policy. In addition, Company A should consider the requirements of Item 
303(b)(3) of Regulation S-K regarding critical accounting estimates in 
MD&A.
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    \14\ See Item 303 of Regulation S-K.
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C. Valuation Methods

    FASB ASC paragraph 718-10-30-6 (Compensation--Stock Compensation 
Topic) indicates that the measurement objective for equity instruments 
awarded to grantees is to estimate at the grant date the fair value of 
the equity instruments the entity is obligated to issue when grantees 
have delivered the good or rendered the service and satisfied any other 
conditions necessary to earn the right to benefit from the 
instruments.\15\ The Topic also states that observable market prices of 
identical or similar equity or liability instruments in active markets 
are the best evidence of fair value and, if available, should be used 
as the basis for the measurement for equity and liability instruments 
awarded in a share-based payment transaction.\16\ However, if 
observable market prices of identical or similar equity or liability 
instruments are not available, the fair value shall be estimated by 
using a valuation technique or model that complies with the measurement 
objective, as described in FASB ASC Topic 718.\17\
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    \15\ FASB ASC paragraph 718-10-30-1 states that this guidance 
applies equally to awards classified as liabilities.
    \16\ FASB ASC paragraph 718-10-55-10.
    \17\ FASB ASC paragraph 718-10-55-11.
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    Question 1: If a valuation technique or model is used to estimate 
fair value, to what extent will the staff consider a company's 
estimates of fair value to be materially misleading because the 
estimates of fair value do not correspond to the value ultimately 
realized by the grantees who received the share options?
    Interpretive Response: The staff understands that estimates of fair 
value of share options, while derived from expected value calculations, 
cannot predict actual future events.\18\ The estimate of fair value 
represents the measurement of the cost of the grantee's goods or 
services to the company. The estimate of fair value should reflect the 
assumptions marketplace participants would use in determining how much 
to pay for an instrument on the fair value measurement date.\19\ For 
example, valuation techniques used in estimating the fair value of 
share options may consider information about a large number of possible 
share price paths, while, of course, only one share price path will 
ultimately emerge. If a company makes a good faith fair value estimate 
in accordance with the provisions of FASB ASC Topic 718 in a way that 
is designed to take into account the assumptions that underlie the 
instrument's value that marketplace participants would reasonably make, 
then subsequent future events that affect the instrument's value do not 
provide meaningful information about the quality of the original fair 
value estimate. As long as the share options were originally so 
measured, changes in a share option's value, no matter how significant, 
subsequent to its grant date do not call into question the 
reasonableness of the grant date fair value estimate.
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    \18\ FASB ASC paragraph 718-10-55-15 states, ``The fair value of 
those instruments at a single point in time is not a forecast of 
what the estimated fair value of those instruments may be in the 
future.''
    \19\ Generally, the grant date for equity awards or the 
reporting date for liability-classified awards.
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    Question 2: In order to meet the fair value measurement objective 
in FASB ASC Topic 718, are certain valuation techniques preferred over 
others?
    Interpretive Response: FASB ASC paragraph 718-10-55-17 clarifies 
that the Topic does not specify a preference for a particular valuation 
technique or model. As stated in FASB ASC paragraph 718-10-55-11 in 
order to meet the fair value measurement objective, a company should 
select a valuation technique or model that (a) is applied in a manner 
consistent with the fair value measurement objective and other 
requirements of FASB ASC Topic 718, (b) is based on established 
principles of financial economic theory and generally applied in that 
field and (c) reflects all substantive characteristics of the 
instrument (except for those explicitly excluded by FASB ASC Topic 
718).
    The chosen valuation technique or model must meet all three of the 
requirements stated above. In valuing a particular instrument, certain 
techniques or models may meet the first and second criteria but may not 
meet the third criterion because the techniques or models are not 
designed to reflect certain characteristics contained in the 
instrument. For example, for a share option in which the exercisability 
is conditional on a specified increase in the price of the underlying 
shares, the Black-Scholes-Merton closed-form model would not generally 
be an appropriate valuation model because, while it meets both the 
first and second criteria, it is not designed to take into account that 
type of market condition.\20\
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    \20\ See FASB ASC paragraphs 718-10-55-16 and 718-10-55-20.
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    Further, the staff understands that a company may consider multiple 
techniques or models that meet the fair value measurement objective 
before making its selection as to the appropriate technique or model. 
The staff would not object to a company's choice of a technique or 
model as long as the technique or model meets the fair value 
measurement objective. For example, a company is not required to use a 
lattice model simply because that model was the most complex of the 
models the company considered.
    Question 3: In subsequent periods, may a company change the 
valuation technique or model chosen to value instruments with similar 
characteristics? \21\
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    \21\ FASB ASC paragraph 718-10-55-17 indicates that an entity 
may use different valuation techniques or models for instruments 
with different characteristics.
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    Interpretive Response: As long as the new technique or model meets 
the fair value measurement objective as described in Question 2 above, 
the staff would not object to a company changing its valuation 
technique or model.\22\ A

[[Page 68115]]

change in the valuation technique or model used to meet the fair value 
measurement objective would not be considered a change in accounting 
principle.\23\ As such, a company would not be required to file a 
preferability letter from its independent accountants as described in 
Rule 10-01(b)(6) of Regulation S-X when it changes valuation techniques 
or models. However, the staff would not expect that a company would 
frequently switch between valuation techniques or models, particularly 
in circumstances where there was no significant variation in the form 
of share-based payments being valued. Disclosure in the footnotes of 
the basis for any change in technique or model would be 
appropriate.\24\
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    \22\ The staff believes that a company should take into account 
the reason for the change in technique or model in determining 
whether the new technique or model meets the fair value measurement 
objective. For example, changing a technique or model from period to 
period for the sole purpose of lowering the fair value estimate of a 
share option would not meet the fair value measurement objective of 
the Topic.
    \23\ FASB ASC paragraph 718-10-55-27.
    \24\ See generally FASB ASC paragraph 718-10-50-1.
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    Question 4: Must every company that issues share options or similar 
instruments hire an outside third party to assist in determining the 
fair value of the share options?
    Interpretive Response: No. However, the valuation of a company's 
share options or similar instruments should be performed by a person 
with the requisite expertise.

D. Certain Assumptions Used in Valuation Methods

    FASB ASC Topic 718's (Compensation--Stock Compensation Topic) fair 
value measurement objective for equity instruments awarded to grantees 
for goods or services is to estimate the grant-date fair value of the 
equity instruments that the entity is obligated to issue when grantees 
have delivered the good or rendered the service and satisfied any other 
conditions necessary to earn the right to benefit from the 
instruments.\25\ In order to meet this fair value measurement 
objective, management will generally be required to develop estimates 
regarding (1) the expected volatility of its company's share price; (2) 
the expected term of the option, taking into account both the 
contractual term of the option and the effects of grantees' expected 
exercise and post-vesting termination behavior; and (3) the 
determination of the current price of the underlying share. The staff 
is providing guidance in the following sections related to the expected 
volatility, expected term and current share price assumptions to assist 
public entities in applying those requirements.
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    \25\ FASB ASC paragraph 718-10-30-6. FASB ASC paragraph 718-10-
30-1 states that this guidance applies equally to awards classified 
as liabilities.
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1. Expected Volatility
    FASB ASC paragraph 718-10-55-36 states, ``Volatility is a measure 
of the amount by which a financial variable, such as share price, has 
fluctuated (historical volatility) or is expected to fluctuate 
(expected volatility) during a period. Option-pricing models require an 
estimate of expected volatility as an assumption because an option's 
value is dependent on potential share returns over the option's term. 
The higher the volatility, the more the returns on the share can be 
expected to vary--up or down. Because an option's value is unaffected 
by expected negative returns on the shares, other things [being] equal, 
an option on a share with higher volatility is worth more than an 
option on a share with lower volatility.''
    Facts: Company B is a public entity whose common shares have been 
publicly traded for over twenty years. Company B also has multiple 
options on its shares outstanding that are traded on an exchange 
(``traded options''). Company B grants share options on January 2, 
20X6.
    Question 1: What should Company B consider when estimating expected 
volatility for purposes of measuring the fair value of its share 
options?
    Interpretive Response: FASB ASC Topic 718 does not specify a 
particular method of estimating expected volatility. However, the Topic 
does clarify that the objective in estimating expected volatility is to 
ascertain the assumption about expected volatility that marketplace 
participants would likely use in determining an exchange price for an 
option.\26\ FASB ASC Topic 718 provides a list of factors entities 
should consider in estimating expected volatility.\27\ Company B may 
begin its process of estimating expected volatility by considering its 
historical volatility.\28\ However, Company B should also then 
consider, based on available information, how the expected volatility 
of its share price may differ from historical volatility.\29\ Implied 
volatility \30\ can be useful in estimating expected volatility because 
it is generally reflective of both historical volatility and 
expectations of how future volatility will differ from historical 
volatility.
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    \26\ FASB ASC paragraph 718-10-55-35.
    \27\ FASB ASC paragraph 718-10-55-37.
    \28\ FASB ASC paragraph 718-10-55-40.
    \29\ Ibid.
    \30\ Implied volatility is the volatility assumption inherent in 
the market prices of a company's traded options or other financial 
instruments that have option-like features. Implied volatility is 
derived by entering the market price of the traded financial 
instrument, along with assumptions specific to the financial options 
being valued, into a model based on a constant volatility estimate 
(e.g., the Black-Scholes-Merton closed-form model) and solving for 
the unknown assumption of volatility.
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    The staff believes that companies should make good faith efforts to 
identify and use sufficient information in determining whether taking 
historical volatility, implied volatility or a combination of both into 
account will result in the best estimate of expected volatility. The 
staff believes companies that have appropriate traded financial 
instruments from which they can derive an implied volatility should 
generally consider this measure. The extent of the ultimate reliance on 
implied volatility will depend on a company's facts and circumstances; 
however, the staff believes that a company with actively traded options 
or other financial instruments with embedded options \31\ generally 
could place greater (or even exclusive) reliance on implied volatility. 
(See the Interpretive Responses to Questions 3 and 4 below.)
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    \31\ The staff believes implied volatility derived from embedded 
options can be utilized in determining expected volatility if, in 
deriving the implied volatility, the company considers all relevant 
features of the instruments (e.g., value of the host instrument, 
value of the option, etc.). The staff believes the derivation of 
implied volatility from other than simple instruments (e.g., a 
simple convertible bond) can, in some cases, be impracticable due to 
the complexity of multiple features.
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    The process used to gather and review available information to 
estimate expected volatility should be applied consistently from period 
to period. When circumstances indicate the availability of new or 
different information that would be useful in estimating expected 
volatility, a company should incorporate that information.
    Question 2: What should Company B consider if computing historical 
volatility? \32\
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    \32\ See FASB ASC paragraph 718-10-55-37.
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    Interpretive Response: The following should be considered in the 
computation of historical volatility:

1. Method of Computing Historical Volatility--

    The staff believes the method selected by Company B to compute its 
historical volatility should produce an estimate that is representative 
of a marketplace participant's expectations about Company B's future 
volatility over the expected (if using a Black-Scholes-Merton closed-
form model) or contractual (if using a lattice model)

[[Page 68116]]

term \33\ of its share options. Certain methods may not be appropriate 
for longer term share options if they weight the most recent periods of 
Company B's historical volatility much more heavily than earlier 
periods.\34\ For example, a method that applies a factor to certain 
historical price intervals to reflect a decay or loss of relevance of 
that historical information emphasizes the most recent historical 
periods and thus would likely bias the estimate to this recent 
history.\35\
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    \33\ For purposes of this staff accounting bulletin, the phrase 
``expected or contractual term, as applicable'' has the same meaning 
as the phrase ``expected (if using a Black-Scholes-Merton closed-
form model) or contractual (if using a lattice model) term of a 
share option.''
    \34\ FASB ASC subparagraph 718-10-55-37(a) states that entities 
should consider historical volatility over a period generally 
commensurate with the expected or contractual term, as applicable, 
of the share option. Accordingly, the staff believes methods that 
place extreme emphasis on the most recent periods may be 
inconsistent with this guidance.
    \35\ Generalized Autoregressive Conditional Heteroskedasticity 
(``GARCH'') is an example of a method that demonstrates this 
characteristic.

---------------------------------------------------------------------------
2. Amount of Historical Data--

    FASB ASC subparagraph 718-10-55-37(a) indicates entities should 
consider historical volatility over a period generally commensurate 
with the expected or contractual term, as applicable, of the share 
option. The staff believes Company B could utilize a period of 
historical data longer than the expected or contractual term, as 
applicable, if it reasonably believes the additional historical 
information will improve the estimate. For example, assume Company B 
decided to utilize a Black-Scholes-Merton closed-form model to estimate 
the value of the share options granted on January 2, 20X6 and 
determined that the expected term was six years. Company B would not be 
precluded from using historical data longer than six years if it 
concludes that data would be relevant.

3. Frequency of Price Observations--

    FASB ASC subparagraph 718-10-55-37(d) indicates an entity should 
use appropriate and regular intervals for price observations based on 
facts and circumstances that provide the basis for a reasonable fair 
value estimate. Accordingly, the staff believes Company B should 
consider the frequency of the trading of its shares and the length of 
its trading history in determining the appropriate frequency of price 
observations. The staff believes using daily, weekly or monthly price 
observations may provide a sufficient basis to estimate expected 
volatility if the history provides enough data points on which to base 
the estimate.\36\ Company B should select a consistent point in time 
within each interval when selecting data points.\37\
---------------------------------------------------------------------------

    \36\ Further, if shares of a company are thinly traded the staff 
believes the use of weekly or monthly price observations would 
generally be more appropriate than the use of daily price 
observations. The volatility calculation using daily observations 
for such shares could be artificially inflated due to a larger 
spread between the bid and asked quotes and lack of consistent 
trading in the market.
    \37\ FASB ASC paragraph 718-10-55-40 states that a company 
should establish a process for estimating expected volatility and 
apply that process consistently from period to period. In addition, 
FASB ASC paragraph 718-10-55-27 indicates that assumptions used to 
estimate the fair value of instruments granted in share-based 
payment transactions should be determined in a consistent manner 
from period to period.

---------------------------------------------------------------------------
4. Consideration of Future Events--

    The objective in estimating expected volatility is to ascertain the 
assumptions that marketplace participants would likely use in 
determining an exchange price for an option.\38\ Accordingly, the staff 
believes that Company B should consider those future events that it 
reasonably concludes a marketplace participant would also consider in 
making the estimation. For example, if Company B has recently announced 
a merger with a company that would change its business risk in the 
future, then it should consider the impact of the merger in estimating 
the expected volatility if it reasonably believes a marketplace 
participant would also consider this event.
---------------------------------------------------------------------------

    \38\ FASB ASC paragraph 718-10-55-35.
---------------------------------------------------------------------------

    The staff believes that careful consideration is required to 
determine whether material non-public information is currently 
available (or would be available) to the issuer that would be 
considered by a marketplace participant in estimating the expected 
volatility.\39\ For example, if Company B has entered into a material 
transaction that has not yet been announced prior to its grant of 
equity instruments, the specific facts and circumstances of the 
material transaction may lead Company B to conclude that the impact of 
this event should be included in estimating the expected volatility 
when determining the grant-date fair value of those equity instruments.
---------------------------------------------------------------------------

    \39\ FASB ASC paragraph 718-10-55-13 states ``assumptions shall 
reflect information that is (or would be) available to form the 
basis for an amount at which the instruments being valued would be 
exchanged. In estimating fair value, the assumptions used shall not 
represent the biases of a particular party.''

---------------------------------------------------------------------------
5. Exclusion of Periods of Historical Data--

    In some instances, due to a company's particular business 
situations, a period of historical volatility data may not be relevant 
in evaluating expected volatility.\40\ In these instances, that period 
should be disregarded. The staff believes that if Company B disregards 
a period of historical volatility, it should be prepared to support its 
conclusion that its historical share price during that previous period 
is not relevant to estimating expected volatility due to one or more 
discrete and specific historical events and that similar events are not 
expected to occur during the expected term of the share option. The 
staff believes these situations would be rare.
---------------------------------------------------------------------------

    \40\ FASB ASC paragraph 718-10-55-37.
---------------------------------------------------------------------------

    Question 3: What should Company B consider when evaluating the 
extent of its reliance on the implied volatility derived from its 
traded options?
    Interpretive Response: To achieve the objective of estimating 
expected volatility as stated in FASB ASC paragraphs 718-10-55-35 
through 718-10-55-41, the staff believes Company B generally should 
consider the following in its evaluation: (1) The volume of market 
activity of the underlying shares and traded options; (2) the ability 
to synchronize the variables used to derive implied volatility; (3) the 
similarity of the exercise prices of the traded options to the exercise 
price of the newly-granted share options; (4) the similarity of the 
length of the term of the traded and newly-granted share options; \41\ 
and (5) consideration of material non-public information.
---------------------------------------------------------------------------

    \41\ See generally Options, Futures, and Other Derivatives by 
John C. Hull (Pearson, 11th Edition, 2021).

---------------------------------------------------------------------------
1. Volume of Market Activity--

    The staff believes Company B should consider the volume of trading 
in its underlying shares as well as the traded options. For example, 
prices for instruments in actively traded markets are more likely to 
reflect a marketplace participant's expectations regarding expected 
volatility.

2. Synchronization of the Variables--

    Company B should synchronize the variables used to derive implied 
volatility. For example, to the extent reasonably practicable, Company 
B should use market prices (either traded prices or the average of bid 
and asked quotes) of the traded options and its shares measured at the 
same point in time. This measurement should also be synchronized with 
the grant of the share options; however, when this is not reasonably 
practicable, the staff believes Company B should derive implied 
volatility as of a point in time as close to the grant of the share 
options as reasonably practicable.


[[Page 68117]]


3. Similarity of the Exercise Prices--

    The staff believes that when valuing an at-the-money share option, 
the implied volatility derived from at- or near-the-money traded 
options generally would be most relevant.\42\ If, however, it is not 
possible to find at- or near-the-money traded options, Company B should 
select multiple traded options with an average exercise price close to 
the exercise price of the share option.\43\
---------------------------------------------------------------------------

    \42\ Implied volatilities of options differ systematically over 
the ``moneyness'' of the option. This pattern of implied 
volatilities across exercise prices is known as the ``volatility 
smile'' or ``volatility skew.'' Studies such as ``Implied 
Volatility'' by Stewart Mayhew, Financial Analysts Journal, July-
August 1995, as well as more recent studies, have found that implied 
volatilities based on near-the-money options do as well as 
sophisticated weighted implied volatilities in estimating expected 
volatility. In addition, the staff believes that because near-the-
money options are generally more actively traded, they may provide a 
better basis for deriving implied volatility.
    \43\ The staff believes a company could use a weighted-average 
implied volatility based on traded options that are either in-the-
money or out-of-the-money. For example, if the share option has an 
exercise price of $52, but the only traded options available have 
exercise prices of $50 and $55, then the staff believes that it is 
appropriate to use a weighted average based on the implied 
volatilities from the two traded options; for this example, a 40% 
weight on the implied volatility calculated from the option with an 
exercise price of $55 and a 60% weight on the option with an 
exercise price of $50.

---------------------------------------------------------------------------
4. Similarity of Length of Terms--

    The staff believes that when valuing a share option with a given 
expected or contractual term, as applicable, the implied volatility 
derived from a traded option with a similar term would be the most 
relevant. However, if there are no traded options with maturities that 
are similar to the share option's contractual or expected term, as 
applicable, then the staff believes Company B could consider traded 
options with a remaining maturity of six months or greater.\44\ 
However, when using traded options with a term of less than one 
year,\45\ the staff would expect the company to also consider other 
relevant information in estimating expected volatility. In general, the 
staff believes more reliance on the implied volatility derived from a 
traded option would be expected the closer the remaining term of the 
traded option is to the expected or contractual term, as applicable, of 
the share option.
---------------------------------------------------------------------------

    \44\ The staff believes it may also be appropriate to consider 
the entire term structure of volatility provided by traded options 
with a variety of remaining maturities. If a company considers the 
entire term structure in deriving implied volatility, the staff 
would expect a company to include some options in the term structure 
with a remaining maturity of six months or greater.
    \45\ The staff believes the implied volatility derived from a 
traded option with a term of one year or greater would typically not 
be significantly different from the implied volatility that would be 
derived from a traded option with a significantly longer term.

---------------------------------------------------------------------------
5. Consideration of Material Nonpublic Information--

    When a company is in possession of material non-public information, 
the staff believes that the related guidance in the interpretive 
response to Question 2 above would also be relevant in determining 
whether the implied volatility appropriately reflects a marketplace 
participant's expectations of future volatility.
    The staff believes Company B's evaluation of the factors above 
should assist in determining whether the implied volatility 
appropriately reflects the market's expectations of future volatility 
and thus the extent of reliance that Company B reasonably places on the 
implied volatility.
    Question 4: Are there situations in which it is acceptable for 
Company B to rely exclusively on either implied volatility or 
historical volatility in its estimate of expected volatility?
    Interpretive Response: As stated above, FASB ASC Topic 718 does not 
specify a method of estimating expected volatility; rather, it provides 
a list of factors that should be considered and requires that an 
entity's estimate of expected volatility be reasonable and 
supportable.\46\ Many of the factors listed in FASB ASC Topic 718 are 
discussed in Questions 2 and 3 above. The objective of estimating 
volatility, as stated in FASB ASC Topic 718, is to ascertain the 
assumption about expected volatility that marketplace participants 
would likely use in determining an exchange price for an option.\47\ 
The staff believes that a company, after considering the factors listed 
in FASB ASC Topic 718, could, in certain situations, reasonably 
conclude that exclusive reliance on either historical or implied 
volatility would provide an estimate of expected volatility that meets 
this stated objective.
---------------------------------------------------------------------------

    \46\ FASB ASC paragraphs 718-10-55-36 through 718-10-55-37.
    \47\ FASB ASC paragraph 718-10-55-35.
---------------------------------------------------------------------------

    The staff would not object to Company B placing exclusive reliance 
on implied volatility when the following factors are present, as long 
as the methodology is consistently applied:
     Company B utilizes a valuation model that is based upon a 
constant volatility assumption to value its share options; \48\
---------------------------------------------------------------------------

    \48\ FASB ASC paragraphs 718-10-55-18 and 718-10-55-39 discuss 
the incorporation of a range of expected volatilities into option 
pricing models. The staff believes that a company that utilizes an 
option pricing model that incorporates a range of expected 
volatilities over the option's contractual term should consider the 
factors listed in FASB ASC Topic 718, and those discussed in the 
Interpretive Responses to Questions 2 and 3 above, to determine the 
extent of its reliance (including exclusive reliance) on the derived 
implied volatility.
---------------------------------------------------------------------------

     The implied volatility is derived from options that are 
actively traded;
     The market prices (trades or quotes) of both the traded 
options and underlying shares are measured at a similar point in time 
to each other and on a date reasonably close to the fair value 
measurement date of the share options;
     The traded options have exercise prices that are both (a) 
near-the-money and (b) close to the exercise price of the share 
options; \49\
---------------------------------------------------------------------------

    \49\ When near-the-money options are not available, the staff 
believes the use of a weighted-average approach, as noted 
previously, may be appropriate.
---------------------------------------------------------------------------

     The remaining maturities of the traded options on which 
the estimate is based are at least one year, and
     Material nonpublic information that would be considered in 
a marketplace participant's expectation of future volatility does not 
exist.
    The staff would not object to Company B placing exclusive reliance 
on historical volatility when the following factors are present, so 
long as the methodology is consistently applied:
     Company B has no reason to believe that its future 
volatility over the expected or contractual term, as applicable, is 
likely to differ from its past; \50\
---------------------------------------------------------------------------

    \50\ See FASB ASC paragraph 718-10-55-38. A change in a 
company's business model that results in a material alteration to 
the company's risk profile is an example of a circumstance in which 
the company's future volatility would be expected to differ from its 
historical volatility. Other examples may include, but are not 
limited to, the introduction of a new product that is central to a 
company's business model or the receipt of U.S. Food and Drug 
Administration approval for the sale of a new prescription drug.
---------------------------------------------------------------------------

     The computation of historical volatility uses a simple 
average calculation method;
     A sequential period of historical data at least equal to 
the expected or contractual term of the share option, as applicable, is 
used; and
     A reasonably sufficient number of price observations are 
used, measured at a consistent point throughout the applicable 
historical period.\51\
---------------------------------------------------------------------------

    \51\ If the expected or contractual term, as applicable, of the 
employee share option is less than three years, the staff believes 
monthly price observations would not provide a sufficient amount of 
data.
---------------------------------------------------------------------------

    Question 5: What disclosures would the staff expect Company B to 
include in its financial statements and MD&A regarding its assumption 
of expected volatility?
    Interpretive Response: FASB ASC paragraph 718-10-50-2 prescribes 
the

[[Page 68118]]

minimum information needed to achieve the Topic's disclosure 
objectives.\52\ Under that guidance, Company B is required to disclose 
the expected volatility and the method used to estimate it.\53\ 
Accordingly, the staff expects that, at a minimum, Company B would 
disclose in a footnote to its financial statements how it determined 
the expected volatility assumption for purposes of determining the fair 
value of its share options in accordance with FASB ASC Topic 718. For 
example, at a minimum, the staff would expect Company B to disclose 
whether it used only implied volatility, historical volatility, or a 
combination of both, and how it determined any significant adjustments 
to historical volatility.
---------------------------------------------------------------------------

    \52\ FASB ASC paragraph 718-10-50-1.
    \53\ FASB ASC subparagraph 718-10-50-2(f) (2) (ii).
---------------------------------------------------------------------------

    In addition, Company B should consider the requirements of 
Regulation S-K Item 303(b)(3) regarding critical accounting estimates 
in MD&A. A company should determine whether its evaluation of any of 
the factors listed in Questions 2 and 3 of this section, such as 
consideration of future events in estimating expected volatility, 
resulted in an estimate that involves a significant level of estimation 
uncertainty and has had or is reasonably likely to have a material 
impact on the financial condition or results of operations of the 
company.
    Facts: Company C is a newly public entity with limited historical 
data on the price of its publicly-traded shares and no other traded 
financial instruments. Company C believes that it does not have 
sufficient company-specific information regarding the volatility of its 
share price on which to base an estimate of expected volatility.
    Question 6: What other sources of information should Company C 
consider in order to estimate the expected volatility of its share 
price?
    Interpretive Response: FASB ASC Topic 718 provides guidance on 
estimating expected volatility for newly-public and nonpublic entities 
that do not have company-specific historical or implied volatility 
information available.\54\ Company C may base its estimate of expected 
volatility on the historical, expected or implied volatility of similar 
entities whose share or option prices are publicly available. In making 
its determination as to similarity, Company C would likely consider the 
industry, stage of life cycle, size and financial leverage of such 
other entities.\55\
---------------------------------------------------------------------------

    \54\ FASB ASC paragraphs 718-10-55-25 and 718-10-55-51.
    \55\ FASB ASC paragraph 718-10-55-25.
---------------------------------------------------------------------------

    The staff would not object to Company C looking to an industry 
sector index (e.g., NASDAQ Computer Index) that is representative of 
Company C's industry, and possibly its size, to identify one or more 
similar entities.\56\ Once Company C has identified similar entities, 
it would substitute a measure of the individual volatilities of the 
similar entities for the expected volatility of its share price as an 
assumption in its valuation model.\57\ Because of the effects of 
diversification that are present in an industry sector index, Company C 
should not substitute the volatility of an index for the expected 
volatility of its share price as an assumption in its valuation 
model.\58\
---------------------------------------------------------------------------

    \56\ If a company operates in a number of different industries, 
it could look to several industry indices. However, when considering 
the volatilities of multiple companies, each operating only in a 
single industry, the staff believes a company should take into 
account its own leverage, the leverages of each of the entities, and 
the correlation of the entities' stock returns.
    \57\ FASB ASC paragraph 718-10-55-51.
    \58\ FASB ASC paragraph 718-10-55-25.
---------------------------------------------------------------------------

    After similar entities have been identified, Company C should 
continue to consider the volatilities of those entities unless 
circumstances change such that the identified entities are no longer 
similar to Company C. Until Company C has sufficient information 
available, the staff would not object to Company C basing its estimate 
of expected volatility on the volatility of similar entities for those 
periods for which it does not have sufficient information 
available.\59\ Until Company C has either a sufficient amount of 
historical information regarding the volatility of its share price or 
other traded financial instruments are available to derive an implied 
volatility to support an estimate of expected volatility, it should 
consistently apply a process as described above to estimate expected 
volatility based on the volatilities of similar entities.\60\
---------------------------------------------------------------------------

    \59\ FASB ASC paragraph 718-10-55-37. The staff believes that at 
least two years of daily or weekly historical data could provide a 
reasonable basis on which to base an estimate of expected volatility 
if a company has no reason to believe that its future volatility 
will differ materially during the expected or contractual term, as 
applicable, from the volatility calculated from this past 
information. If the expected or contractual term, as applicable, of 
a share option is shorter than two years, the staff believes a 
company should use daily or weekly historical data for at least the 
length of that applicable term.
    \60\ FASB ASC paragraph 718-10-55-40.
---------------------------------------------------------------------------

2. Expected Term
    FASB ASC paragraph 718-10-55-29 states, ``The fair value of a 
traded (or transferable) share option is based on its contractual term 
because rarely is it economically advantageous to exercise, rather than 
sell, a transferable share option before the end of its contractual 
term. Employee share options generally differ from transferable [or 
tradable] share options in that employees cannot sell (or hedge) their 
share options--they can only exercise them; because of this, employees 
generally exercise their options before the end of the options' 
contractual term. Thus, the inability to sell or hedge an employee 
share option effectively reduces the option's value [compared to a 
transferable option] because exercise prior to the option's expiration 
terminates its remaining life and thus its remaining time value.'' 
Accordingly, FASB ASC Topic 718 requires that when valuing an employee 
share option under the Black-Scholes-Merton framework the fair value of 
employee share options be based on the share options' expected term 
rather than the contractual term.
    FASB ASC paragraph 718-10-55-29A states, ``On an award-by-award 
basis, an entity may elect to use the contractual term as the expected 
term when estimating the fair value of a nonemployee award to satisfy 
the measurement objective in paragraph 718-10-30-6. Otherwise, an 
entity shall apply the guidance in [Topic 718] in estimating the 
expected term of a nonemployee award, which may result in a term less 
than the contractual term of the award. If an entity does not elect to 
use the contractual term as the expected term, similar considerations 
discussed in paragraph 718-10-55-29, such as the inability to sell or 
hedge a nonemployee award, apply when estimating its expected term.''
    The staff believes the estimate of expected term should be based on 
the facts and circumstances available in each particular case. 
Consistent with our Topic 14 introductory guidance regarding 
reasonableness, the fact that other possible estimates are later 
determined to have more accurately reflected the term does not 
necessarily mean that the particular choice was unreasonable. The staff 
reminds registrants of the expected term disclosure requirements 
described in FASB ASC subparagraph 718-10-50-2(f)(2)(i).
    Facts: Company D utilizes the Black-Scholes-Merton closed-form 
model to value its share options for the purposes of determining the 
fair value of the options under FASB ASC Topic 718. Company D recently 
granted share options to its employees. Based on its review of various 
factors, Company D determines that the expected term of the options is 
six years, which is less than the contractual term of ten years.

[[Page 68119]]

    Question 1: When determining the fair value of the share options in 
accordance with FASB ASC Topic 718, should Company D consider an 
additional discount for nonhedgability and nontransferability?
    Interpretive Response: No. FASB ASC paragraph 718-10-55-29 
indicates that nonhedgability and nontransferability have the effect of 
increasing the likelihood that an employee share option will be 
exercised before the end of its contractual term. Nonhedgability and 
nontransferability therefore factor into the expected term assumption 
(in this case reducing the term assumption from ten years to six 
years), and the expected term reasonably adjusts for the effect of 
these factors. Accordingly, the staff believes that no additional 
reduction in the term assumption or other discount to the estimated 
fair value is appropriate for these particular factors.\61\
---------------------------------------------------------------------------

    \61\ The staff notes the existence of academic literature that 
supports the assertion that the Black-Scholes-Merton closed-form 
model, with expected term as an input, can produce reasonable 
estimates of fair value. Such literature includes J. Carpenter, 
``The exercise and valuation of executive stock options,'' Journal 
of Financial Economics, May 1998, pp.127-158; C. Marquardt, ``The 
Cost of Employee Stock Option Grants: An Empirical Analysis,'' 
Journal of Accounting Research, September 2002, pp. 1191-1217); and 
J. Bettis, J. Bizjak and M. Lemmon, ``Exercise behavior, valuation, 
and the incentive effect of employee stock options,'' Journal of 
Financial Economics, May 2005, pp. 445-470, as well as more recent 
studies,.
---------------------------------------------------------------------------

    Question 2: Should forfeitures or terms that stem from 
forfeitability be factored into the determination of expected term?
    Interpretive Response: No. FASB ASC Topic 718 indicates that the 
expected term that is utilized as an assumption in a closed-form 
option-pricing model or a resulting output of a lattice option pricing 
model when determining the fair value of the share options should not 
incorporate restrictions or other terms that stem from the pre-vesting 
forfeitability of the instruments. Under FASB ASC Topic 718, these pre-
vesting restrictions or other terms are taken into account by 
ultimately recognizing compensation cost only for awards for which 
grantees deliver the good or render the service.\62\
---------------------------------------------------------------------------

    \62\ FASB ASC paragraph 718-10-30-11.
---------------------------------------------------------------------------

    Question 3: Can a company's estimate of expected term ever be 
shorter than the vesting period?
    Interpretive Response: No. The vesting period forms the lower bound 
of the estimate of expected term.\63\
---------------------------------------------------------------------------

    \63\ FASB ASC paragraph 718-10-55-31.
---------------------------------------------------------------------------

    Question 4: FASB ASC paragraph 718-10-55-34 indicates that an 
entity shall aggregate individual awards into relatively homogenous 
groups with respect to exercise and post-vesting employment termination 
behaviors for the purpose of determining expected term, regardless of 
the valuation technique or model used to estimate the fair value. How 
many groupings are typically considered sufficient?
    Interpretive Response: As it relates to employee groupings, the 
staff believes that an entity may generally make a reasonable fair 
value estimate with as few as one or two groupings.\64\
---------------------------------------------------------------------------

    \64\ The staff believes the focus should be on groups of 
employees with significantly different expected exercise behavior. 
Academic research suggests two such groups might be executives and 
non-executives. A study by S. Huddart found executives and other 
senior managers to be significantly more patient in their exercise 
behavior than more junior employees. (Employee rank was proxied for 
by the number of options issued to that employee.) See S. Huddart, 
``Patterns of stock option exercise in the United States,'' in: J. 
Carpenter and D. Yermack, eds., Executive Compensation and 
Shareholder Value: Theory and Evidence (Kluwer, Boston, MA, 1999), 
pp. 115-142. See also S. Huddart and M. Lang, ``Employee stock 
option exercises: An empirical analysis,'' Journal of Accounting and 
Economics, 1996, pp. 5-43.
---------------------------------------------------------------------------

    Question 5: What approaches could a company use to estimate the 
expected term of its employee share options?
    Interpretive Response: A company should use an approach that is 
reasonable and supportable under FASB ASC Topic 718's fair value 
measurement objective, which establishes that assumptions and 
measurement techniques should be consistent with those that marketplace 
participants would be likely to use in determining an exchange price 
for the share options.\65\ If, in developing its estimate of expected 
term, a company determines that its historical share option exercise 
experience is the best estimate of future exercise patterns, the staff 
will not object to the use of the historical share option exercise 
experience to estimate expected term.\66\
---------------------------------------------------------------------------

    \65\ FASB ASC paragraph 718-10-55-13.
    \66\ Historical share option exercise experience encompasses 
data related to share option exercise, post-vesting termination, and 
share option contractual term expiration.
---------------------------------------------------------------------------

    A company may also conclude that its historical share option 
exercise experience does not provide a reasonable basis upon which to 
estimate expected term. This may be the case for a variety of reasons, 
including, but not limited to, the life of the company and its relative 
stage of development, past or expected structural changes in the 
business, differences in terms of past equity-based share option 
grants,\67\ or a lack of variety of price paths that the company may 
have experienced.\68\
---------------------------------------------------------------------------

    \67\ For example, if a company had historically granted share 
options that were always in-the-money, and will grant at-the-money 
options prospectively, the exercise behavior related to the in-the-
money options may not be sufficient as the sole basis to form the 
estimate of expected term for the at-the-money grants.
    \68\ For example, if a company had a history of previous equity-
based share option grants and exercises only in periods in which the 
company's share price was rising, the exercise behavior related to 
those options may not be sufficient as the sole basis to form the 
estimate of expected term for current option grants.
---------------------------------------------------------------------------

    FASB ASC Topic 718 describes other alternative sources of 
information that might be used in those cases when a company determines 
that its historical share option exercise experience does not provide a 
reasonable basis upon which to estimate expected term. For example, a 
lattice model (which by definition incorporates multiple price paths) 
can be used to estimate expected term as an input into a Black-Scholes-
Merton closed-form model.\69\ In addition, FASB ASC paragraph 718-10-
55-32 states that ``. . . expected term might be estimated in some 
other manner, taking into account whatever relevant and supportable 
information is available, including industry averages and other 
pertinent evidence such as published academic research.'' For example, 
data about exercise patterns of employees in similar industries and/or 
situations as the company's might be used.
---------------------------------------------------------------------------

    \69\ FASB ASC paragraph 718-10-55-30.
---------------------------------------------------------------------------

    Facts: Company E grants equity share options to its employees that 
have the following basic characteristics: \70\
---------------------------------------------------------------------------

    \70\ Employee share options with these features are sometimes 
referred to as ``plain vanilla'' options.
---------------------------------------------------------------------------

     The share options are granted at-the-money;
     Exercisability is conditional only on performing service 
through the vesting date; \71\
---------------------------------------------------------------------------

    \71\ In this fact pattern the requisite service period equals 
the vesting period.
---------------------------------------------------------------------------

     If an employee terminates service prior to vesting, the 
employee would forfeit the share options;
     If an employee terminates service after vesting, the 
employee would have a limited time to exercise the share options 
(typically 30-90 days); and
     The share options are nontransferable and nonhedgeable.
    Company E utilizes the Black-Scholes-Merton closed-form model for 
valuing its employee share options.
    Question 6: As share options with these ``plain vanilla'' 
characteristics have been granted in significant quantities by many 
companies in the past, is the staff aware of any ``simple'' 
methodologies that can be used to estimate expected term?
    Interpretive Response: The staff understands that an entity that is 
unable to rely on its historical exercise data

[[Page 68120]]

may find that certain alternative information, such as exercise data 
relating to employees of other companies, is not easily obtainable. As 
such, some companies may encounter difficulties in making a refined 
estimate of expected term. Accordingly, if a company concludes that its 
historical share option exercise experience does not provide a 
reasonable basis upon which to estimate expected term, the staff will 
accept the following ``simplified'' method for ``plain vanilla'' 
options consistent with those in the fact set above: Expected term = 
((vesting term + original contractual term)/2). Assuming a ten year 
original contractual term and graded vesting over four years (25% of 
the options in each grant vest annually) for the share options in the 
fact set described above, the resultant expected term would be 6.25 
years.\72\ Academic research on the exercise of options issued to 
executives provides some general support for outcomes that would be 
produced by the application of this method.\73\
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    \72\ Calculated as [[[1 year vesting term (for the first 25% 
vested) plus 2 year vesting term (for the second 25% vested) plus 3 
year vesting term (for the third 25% vested) plus 4 year vesting 
term (for the last 25% vested)] divided by 4 total years of vesting] 
plus 10 year contractual life] divided by 2; that is, (((1+2+3+4)/4) 
+ 10)/2 = 6.25 years.
    \73\ J.N. Carpenter, ``The exercise and valuation of executive 
stock options,'' Journal of Financial Economics, 1998, pp.127-158 
studies a sample of 40 NYSE and AMEX firms over the period 1979-1994 
with share option terms reasonably consistent to the terms presented 
in the fact set and example. The mean time to exercise after grant 
was 5.83 years and the median was 6.08 years. The ``mean time to 
exercise'' is shorter than expected term since the study's sample 
included only exercised options. Other research on executive options 
includes (but is not limited to) J. Carr Bettis; John M. Bizjak; and 
Michael L. Lemmon, ``Exercise behavior, valuation, and the incentive 
effects of employee stock options,'' Journal of Financial Economics, 
May 2005, pp. 445-470. One of the few studies on nonexecutive 
employee options the staff is aware of is S. Huddart, ``Patterns of 
stock option exercise in the United States,'' in: J. Carpenter and 
D. Yermack, eds., Executive Compensation and Shareholder Value: 
Theory and Evidence (Kluwer, Boston, MA, 1999), pp. 115-142.
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    Examples of situations in which the staff believes that it may be 
appropriate to use this simplified method include the following:
     A company does not have sufficient historical exercise 
data to provide a reasonable basis upon which to estimate expected term 
due to the limited period of time its equity shares have been publicly 
traded.
     A company significantly changes the terms of its share 
option grants or the types of employees that receive share option 
grants such that its historical exercise data may no longer provide a 
reasonable basis upon which to estimate expected term.
     A company has or expects to have significant structural 
changes in its business such that its historical exercise data may no 
longer provide a reasonable basis upon which to estimate expected term.
    The staff understands that a company may have sufficient historical 
exercise data for some of its share option grants but not for others. 
In such cases, the staff will accept the use of the simplified method 
for only some but not all share option grants. The staff also does not 
believe that it is necessary for a company to consider using a lattice 
model before it decides that it is eligible to use this simplified 
method. Further, the staff will not object to the use of this 
simplified method in periods prior to the time a company's equity 
shares are traded in a public market.
    If a company uses this simplified method, the company should 
disclose in the notes to its financial statements the use of the 
method, the reason why the method was used, the types of share option 
grants for which the method was used if the method was not used for all 
share option grants, and the periods for which the method was used if 
the method was not used in all periods. Companies that have sufficient 
historical share option exercise experience upon which to estimate 
expected term may not apply this simplified method. In addition, this 
simplified method is not intended to be applied as a benchmark in 
evaluating the appropriateness of more refined estimates of expected 
term.
    The staff does not expect that such a simplified method would be 
used for share option grants when more relevant detailed information is 
available to the company.
3. Current Price of the Underlying Share (Including Considerations for 
Spring-Loaded Grants)
    FASB ASC paragraph 718-10-55-21 states that ``if an observable 
market price is not available for a share option or similar instrument 
with the same or similar terms and conditions, an entity shall estimate 
the fair value of that instrument using a valuation technique or model 
that meets the requirements in paragraph 718-10-55-11,'' and requires 
such valuation technique or model to take into account, at a minimum a 
number of factors including the current price of the underlying share.
    FASB ASC paragraph 718-10-55-27 states, ``Assumptions used to 
estimate the fair value of equity and liability instruments granted in 
share-based payment transactions shall be determined in a consistent 
manner from period to period. For example, an entity might use the 
closing share price or the share price at another specified time as the 
current share price on the grant date in estimating fair value, but 
whichever method is selected, it shall be used consistently.''
    For a valuation technique to be consistent with the fair value 
measurement objective and the other requirements of Topic 718, the 
staff believes that a consistently applied method to determine the 
current price of the underlying share should include consideration of 
whether adjustments to observable market prices (e.g., the closing 
share price or the share price at another specified time) are required. 
Such adjustments may be required, for example, when the observable 
market price does not reflect certain material non-public information 
known to the company but unavailable to marketplace participants at the 
time the market price is observed.
    Determining whether an adjustment to the observable market price is 
necessary, and if so, the magnitude of any adjustment, requires 
significant judgment. The staff acknowledges that companies generally 
possess non-public information when entering into share-based payment 
transactions. The staff believes that an observable market price on the 
grant date is generally a reasonable and supportable estimate of the 
current price of the underlying share in a share-based payment 
transaction, for example, when estimating the grant-date fair value of 
a routine annual grant to employees that is not designed to be spring-
loaded.
    However, companies should carefully consider whether an adjustment 
to the observable market price is required, for example, when share-
based payments arrangements are entered into in contemplation of or 
shortly before a planned release of material non-public information, 
and such information is expected to result in a material increase in 
share price. The staff believes that non-routine spring-loaded grants 
merit particular scrutiny by those charged with compensation and 
financial reporting governance. Additionally, when a company has a 
planned release of material non-public information within a short 
period of time after the measurement date of a share-based payment, the 
staff believes a material increase in the market price of the company's 
shares upon release of such information indicates marketplace 
participants would have considered an adjustment to the observable 
market price on the measurement date to determine the current price of 
the underlying share.

[[Page 68121]]

    Facts: Company D is a public company that entered into a material 
contract with a customer after market close. Subsequent to entering 
into the contract but before the market opens the next trading day, 
Company D awards share options to its executives. The share option 
award is non-routine, and the award is approved by the Board of 
Directors in contemplation of the material contract. Company D expects 
the share price to increase significantly once the announcement of the 
contract is made the next day. Company D's accounting policy is to 
consistently use the closing share price on the day of the grant as the 
current share price in estimating the grant-date fair value of share 
options.
    Question 1: Should Company D make an adjustment to the closing 
share price to determine the current price of shares underlying share 
options?
    Interpretive Response: Prior to awarding share options in this fact 
pattern, the staff expects Company D to consider whether such awards 
are consistent with its policies and procedures, including the terms of 
the compensation plan approved by shareholders, other governance 
policies, and legal requirements. The staff reminds companies of the 
importance of strong corporate governance and controls in granting 
share options, as well as the requirements to maintain effective 
internal control over financial reporting and disclosure controls and 
procedures.
    In estimating the grant-date fair value of share options in this 
fact pattern, absent an adjustment to the closing share price to 
reflect the impact of Company D's new material contract with a 
customer, the staff believes the closing share price would not be a 
reasonable and supportable estimate and, without an adjustment the 
valuation of the award would not meet the fair value measurement 
objective of FASB ASC Topic 718 because the closing share price would 
not reflect a price that is unbiased for marketplace participants at 
the time of the grant.\74\
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    \74\ FASB ASC paragraph 718-10-55-13.
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    Question 2: What disclosures would the staff expect Company D to 
include in its financial statements regarding its determination of the 
current price of shares underlying newly-granted share options?
    Interpretive Response: FASB ASC paragraph 718-10-50-1 requires 
disclosure of information that enables users of the financial 
statements to understand, among other things, the nature and terms of 
share-based payment arrangements that existed during the period and the 
potential effects of those arrangements on shareholders. FASB ASC 
paragraph 718-10-50-2 prescribes the minimum information needed to 
achieve the Topic's disclosure objectives, including a description of 
the method used and significant assumptions used to estimate the fair 
value of awards under share-based payment arrangements.
    Accordingly, the staff expects that, at a minimum, Company D would 
disclose in a footnote to its financial statements how it determined 
the current price of shares underlying share options for purposes of 
determining the grant-date fair value of its share options in 
accordance with FASB ASC Topic 718. For example, the staff would expect 
Company D to disclose its accounting policy related to how it 
identifies when an adjustment to the closing price is required, how it 
determined the amount of the adjustment to the closing share price, and 
any significant assumptions used to determine such adjustment, if 
material. Further, the characteristics of the share options, including 
their spring-loaded nature, may differ from Company D's other share-
based payment arrangements to such an extent Company D should disclose 
information regarding these share options separately from other share-
based payment arrangements to allow investors to understand Company D's 
use of share-based compensation.\75\
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    \75\ ASC 718-10-50-1 and 718-10-50-2(g).
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    Additionally, Company D should consider the applicability of MD&A 
and other disclosure requirements, including those related to liquidity 
and capital resources, results of operations, critical accounting 
estimates, executive compensation, and transactions with related 
persons.\76\
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    \76\ Items 303, 402, and 404 of Regulation S-K.
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E. FASB ASC Topic 718, Compensation--Stock Compensation, and Certain 
Redeemable Financial Instruments

    Certain financial instruments awarded in conjunction with share-
based payment arrangements have redemption features that require 
settlement by cash or other assets upon the occurrence of events that 
are outside the control of the issuer.\77\ FASB ASC Topic 718 provides 
guidance for determining whether instruments granted in conjunction 
with share-based payment arrangements should be classified as liability 
or equity instruments. Under that guidance, most instruments with 
redemption features that are outside the control of the issuer are 
required to be classified as liabilities; however, some redeemable 
instruments will qualify for equity classification.\78\ SEC Accounting 
Series Release No. 268, Presentation in Financial Statements of 
``Redeemable Preferred Stocks,'' \79\ (``ASR 268'') and related 
guidance \80\ address the classification and measurement of certain 
redeemable equity instruments.
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    \77\ The terminology ``outside the control of the issuer'' is 
used to refer to any of the three redemption conditions described in 
Rule 5-02.27 of Regulation S-X that would require classification 
outside permanent equity. That rule requires preferred securities 
that are redeemable for cash or other assets to be classified 
outside of permanent equity if they 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.
    \78\ FASB ASC paragraphs 718-10-25-6 through 718-10-25-19A.
    \79\ ASR 268, July 27, 1979, Rule 5-02.27 of Regulation S-X.
    \80\ Related guidance includes EITF Topic No. D-98, 
Classification and Measurement of Redeemable Securities, included in 
the FASB ASC in paragraph 480-10-S99-3A.
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    Facts: Under a share-based payment arrangement, Company F grants to 
an employee shares (or share options) that all vest at the end of four 
years (cliff vest). The shares (or shares underlying the share options) 
are redeemable for cash at fair value at the holder's option, but only 
after six months from the date of share issuance (as defined in FASB 
ASC Topic 718). Company F has determined that the shares (or share 
options) would be classified as equity instruments under the guidance 
of FASB ASC Topic 718. However, under ASR 268 and related guidance, the 
instruments would be considered to be redeemable for cash or other 
assets upon the occurrence of events (e.g., redemption at the option of 
the holder) that are outside the control of the issuer.
    Question 1: While the instruments are subject to FASB ASC Topic 
718, is ASR 268 and related guidance applicable to instruments issued 
under share-based payment arrangements that are classified as equity 
instruments under FASB ASC Topic 718?
    Interpretive Response: Yes. The staff believes that registrants 
must evaluate whether the terms of instruments granted in conjunction 
with share-based payment arrangements that are not classified as 
liabilities under FASB ASC Topic 718 result in the need to present 
certain amounts outside of permanent equity (also referred to as being 
presented in ``temporary equity'') in accordance with ASR 268 and 
related guidance.\81\
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    \81\ Instruments granted in conjunction with share-based payment 
arrangements with employees that do not by their terms require 
redemption for cash or other assets (at a fixed or determinable 
price on a fixed or determinable date, at the option of the holder, 
or upon the occurrence of an event that is not solely within the 
control of the issuer) would not be assumed by the staff to require 
net cash settlement for purposes of applying ASR 268 in 
circumstances in which FASB ASC Section 815-40-25, Derivatives and 
Hedging--Contracts in Entity's Own Equity--Recognition, would 
otherwise require the assumption of net cash settlement. See FASB 
ASC paragraph 815-40-25-11 (See FASB ASC paragraph 815-10-65-1 for 
the transition and effective date information related to FASB ASU 
No. 2020-06, Debt--Debt with Conversion and Other Options (Subtopic 
470-20) and Derivatives and Hedging--Contracts in Entity's Own 
Equity (Subtopic 815-40): Accounting for Convertible Instruments and 
Contracts in an Entity's Own Equity, which superseded FASB ASC 
paragraph 815-40-25-11.), which states, in part: ``. . . the events 
or actions necessary to deliver registered shares are not controlled 
by an entity and, therefore, except under the circumstances 
described in FASB ASC paragraph 815-40-25-16, if the contract 
permits the entity to net share or physically settle the contract 
only by delivering registered shares, it is assumed that the entity 
will be required to net cash settle the contract.'' See also FASB 
ASC subparagraph 718-10-25-15(a).

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[[Page 68122]]

    When an instrument ceases to be subject to FASB ASC Topic 718 and 
becomes subject to the recognition and measurement requirements of 
other applicable GAAP, the staff believes that the company should 
reassess the classification of the instrument as a liability or equity 
at that time and consequently may need to reconsider the applicability 
of ASR 268.
    Question 2: How should Company F apply ASR 268 and related guidance 
to the shares (or share options) granted under the share-based payment 
arrangements with employees that may be unvested at the date of grant?
    Interpretive Response: Under FASB ASC Topic 718, when compensation 
cost is recognized for instruments classified as equity instruments, 
additional paid-in-capital \82\ is increased. If the award is not fully 
vested at the grant date, compensation cost is recognized and 
additional paid-in-capital is increased over time as services are 
rendered over the requisite service period. A similar pattern of 
recognition should be used to reflect the amount presented as temporary 
equity for share-based payment awards that have redemption features 
that are outside the issuer's control but are classified as equity 
instruments under FASB ASC Topic 718. The staff believes Company F 
should present as temporary equity at each balance sheet date an amount 
that is based on the redemption amount of the instrument, but takes 
into account the proportion of consideration received in the form of 
employee services. Thus, for example, if a nonvested share that 
qualifies for equity classification under FASB ASC Topic 718 is 
redeemable at fair value more than six months after vesting, and that 
nonvested share is 75% vested at the balance sheet date, an amount 
equal to 75% of the fair value of the share should be presented as 
temporary equity at that date. Similarly, if an option on a share of 
redeemable stock that qualifies for equity classification under FASB 
ASC Topic 718 is 75% vested at the balance sheet date, an amount equal 
to 75% of the intrinsic \83\ value of the option should be presented as 
temporary equity at that date.
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    \82\ Depending on the fact pattern, this may be recorded as 
common stock and additional paid in capital.
    \83\ The potential redemption amount of the share option in this 
illustration is its intrinsic value because the holder would pay the 
exercise price upon exercise of the option and then, upon redemption 
of the underlying shares, the company would pay the holder the fair 
value of those shares. Thus, the net cash outflow from the 
arrangement would be equal to the intrinsic value of the share 
option. In situations where there would be no cash inflows from the 
share option holder, the cash required to be paid to redeem the 
underlying shares upon the exercise of the put option would be the 
redemption value.
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    Question 3: Would the methodology described for employee awards in 
the Interpretive Response to Question 2 above apply to nonemployee 
awards to be issued in exchange for goods or services with similar 
terms to those described above?
    Interpretive Response: The staff believes it would generally be 
appropriate to apply the methodology described in the Interpretive 
Response to Question 2 above to nonemployee awards.

F. Classification of Compensation Expense Associated With Share-Based 
Payment Arrangements

    Facts: Company G utilizes both cash and share-based payment 
arrangements to compensate its employees and nonemployee service 
providers. Company G would like to emphasize in its income statement 
the amount of its compensation that did not involve a cash outlay.
    Question: How should Company G present in its income statement the 
non-cash nature of its expense related to share-based payment 
arrangements?
    Interpretive Response: The staff believes Company G should present 
the expense related to share-based payment arrangements in the same 
line or lines as cash compensation paid to the same employees or 
nonemployees.\84\ The staff believes a company could consider 
disclosing the amount of expense related to share-based payment 
arrangements included in specific line items in the financial 
statements. Disclosure of this information might be appropriate in a 
parenthetical note to the appropriate income statement line items, on 
the cash flow statement, in the footnotes to the financial statements, 
or within MD&A.
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    \84\ FASB ASC Topic 718 does not identify a specific line item 
in the income statement for presentation of the expense related to 
share-based payment arrangements, with the exception of the guidance 
in ASC 718-10-15-5A on share-based payment awards granted to a 
customer.
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G. Removed by SAB 114

H. Removed by SAB 114

I. Capitalization of Compensation Cost Related to Share-Based Payment 
Arrangements

    Facts: Company K is a manufacturing company that grants share 
options to its production employees. Company K has determined that the 
cost of the production employees' service is an inventoriable cost. As 
such, Company K is required to initially capitalize the cost of the 
share option grants to these production employees as inventory and 
later recognize the cost in the income statement when the inventory is 
consumed.\85\
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    \85\ FASB ASC paragraph 718-10-25-2A.
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    Question: If Company K elects to adjust its period end inventory 
balance for the allocable amount of share-option cost through a period 
end adjustment to its financial statements, instead of incorporating 
the share-option cost through its inventory costing system, would this 
be considered a deficiency in internal controls?
    Interpretive Response: No. FASB ASC Topic 718, Compensation--Stock 
Compensation, does not prescribe the mechanism a company should use to 
incorporate a portion of share-option costs in an inventory-costing 
system. The staff believes Company K may accomplish this through a 
period end adjustment to its financial statements. Company K should 
establish appropriate controls surrounding the calculation and 
recording of this period end adjustment, as it would any other period 
end adjustment. The fact that the entry is recorded as a period end 
adjustment, by itself, should not impact management's ability to 
determine that the internal control over financial reporting, as 
defined by the SEC's rules implementing Section 404 of the Sarbanes-
Oxley Act of 2002,\86\ is effective.
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    \86\ Release No. 34-47986, June 5, 2003, Management's Report on 
Internal Control Over Financial Reporting and Certification of 
Disclosure in Exchange Act Period Reports.

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[[Page 68123]]

J. Removed by SAB 114

K. Removed by SAB 114

L. Removed by SAB 114

M. Removed by SAB 114

* * * * *

Topic 5: Miscellaneous Accounting

* * * * *

T. Accounting for Expenses or Liabilities Paid by Principal 
Stockholder(s)

    Facts: Company X was a defendant in litigation for which the 
company had not recorded a liability in accordance with FASB ASC Topic 
450, Contingencies. A principal stockholder \34\ of the company 
transfers a portion of his shares to the plaintiff to settle such 
litigation. If the company had settled the litigation directly, the 
company would have recorded the settlement as an expense.
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    \34\ The FASB ASC Master Glossary defines principal owners as 
``owners of record or known beneficial owners of more than 10 
percent of the voting interests of the enterprise.''
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    Question: Must the settlement be reflected as an expense in the 
company's financial statements, and if so, how?
    Interpretive Response: Yes. The value of the shares transferred 
should be reflected as an expense in the company's financial statements 
with a corresponding credit to contributed (paid-in) capital.
    The staff believes that such a transaction is similar to those 
described in FASB ASC paragraph 718-10-15-4 (Compensation--Stock 
Compensation Topic), which states that ``share-based payments awarded 
to a grantee by a related party or other holder of an economic interest 
\35\ in the entity as compensation for goods or services provided to 
the reporting entity are share-based payment transactions to be 
accounted for under this Topic unless the transfer is clearly for a 
purpose other than compensation for goods or services to the reporting 
entity.'' As explained in this paragraph, the substance of such a 
transaction is that the economic interest holder makes a capital 
contribution to the reporting entity, and the reporting entity makes a 
share-based payment to its grantee in exchange for goods or services 
provided to the reporting entity.
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    \35\ The FASB ASC Master Glossary defines an economic interest 
in an entity as ``any type or form of pecuniary interest or 
arrangement that an entity could issue or be a party to, including 
equity securities; financial instruments with characteristics of 
equity, liabilities or both; long-term debt and other debt-financing 
arrangements; leases; and contractual arrangements such as 
management contracts, service contracts, or intellectual property 
licenses.'' Accordingly, a principal stockholder would be considered 
a holder of an economic interest in an entity.
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    The staff believes that the problem of separating the benefit to 
the principal stockholder from the benefit to the company cited in FASB 
ASC Topic 718 is not limited to transactions involving stock 
compensation. Therefore, similar accounting is required in this and 
other \36\ transactions where a principal stockholder pays an expense 
for the company, unless the stockholder's action is caused by a 
relationship or obligation completely unrelated to his position as a 
stockholder or such action clearly does not benefit the company.
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    \36\ For example, SAB Topic 1.B indicates that the separate 
financial statements of a subsidiary should reflect any costs of its 
operations which are incurred by the parent on its behalf. 
Additionally, the staff notes that AICPA Technical Practice Aids 
Sec.  4160 also indicates that the payment by principal stockholders 
of a company's debt should be accounted for as a capital 
contribution.
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    Some registrants and their accountants have taken the position that 
since FASB ASC Topic 850, Related Party Disclosures, applies to these 
transactions and requires only the disclosure of material related party 
transactions, the staff should not analogize to the accounting called 
for by FASB ASC paragraph 718-10-15-4 for transactions other than those 
specifically covered by it. The staff notes, however, that FASB ASC 
Topic 850 does not address the measurement of related party 
transactions and that, as a result, such transactions are generally 
recorded at the amounts indicated by their terms.\37\ However, the 
staff believes that transactions of the type described above differ 
from the typical related party transactions.
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    \37\ However, in some circumstances it is necessary to reflect, 
either in the historical financial statements or a pro forma 
presentation (depending on the circumstances), related party 
transactions at amounts other than those indicated by their terms. 
Two such circumstances are addressed in Staff Accounting Bulletin 
Topic 1.B.1, Questions 3 and 4. Another example is where the terms 
of a material contract with a related party are expected to change 
upon the completion of an offering (i.e., the principal shareholder 
requires payment for services which had previously been contributed 
by the shareholder to the company).
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    The transactions for which FASB ASC Topic 850 requires disclosure 
generally are those in which a company receives goods or services 
directly from, or provides goods or services directly to, a related 
party, and the form and terms of such transactions may be structured to 
produce either a direct or indirect benefit to the related party. The 
participation of a related party in such a transaction negates the 
presumption that transactions reflected in the financial statements 
have been consummated at arm's length. Disclosure is therefore required 
to compensate for the fact that, due to the related party's 
involvement, the terms of the transaction may produce an accounting 
measurement for which a more faithful measurement may not be 
determinable.
    However, transactions of the type discussed in the facts given do 
not have such problems of measurement and appear to be transacted to 
provide a benefit to the stockholder through the enhancement or 
maintenance of the value of the stockholder's investment. The staff 
believes that the substance of such transactions is the payment of an 
expense of the company through contributions by the stockholder. 
Therefore, the staff believes it would be inappropriate to account for 
such transactions according to the form of the transaction.
* * * * *
* * * * *
[FR Doc. 2021-26027 Filed 11-30-21; 8:45 am]
BILLING CODE P