apportioning replacement awards between compensation and consideration

As discussed in Section 11.7, the buyer in a business combination may issue replacement share-based payment awards to employees of the target. Also as discussed in Section 11.7, the buyer should use Topic 718 to measure these awards. Some or all of the amount measured for these awards under Topic 718 (the Topic 718 value) is treated as part of the consideration transferred in the business combination (see Section 12.3).

The steps that must be taken to determine the portion of the replacement awards that should be treated as consideration transferred or compensation are as follows:

1. Measure both the replacement awards and the awards being replaced (i.e., the target’s awards) in accordance with Topic 718 as of the acquisition date using assumptions that reflect the conditions (e.g., volatility, expected terminations) at the acquisition date, not the conditions at the date the original award was granted;

2. Determine which of the following service periods is longer: (a) the total service period (the sum of the requisite service period for the target’s awards completed prior to the acquisition date and the requisite service period (if any) for the replacement awards to be completed after the acquisition date) or (b) the service period of the target’s award;

3. Determine the ratio of the precombination service period (the portion of the target’s awards’ requisite service period completed prior to the acquisition date) to the longer of the service periods identified in (2);

4. Multiply the Topic 718 value of the target’s awards by the ratio determined in (3) to identify the portion of the replacement awards’ Topic 718 value attributable to precombination service;

5. Calculate the excess of the replacement awards’ Topic 718 value over the amount calculated in (4) to identify the portion of the replacement awards’ Topic 718 value attributable to postcombination service; and

6. Treat the amount determined in (4) as part of the consideration transferred in the business combination and the amount determined in (5) as post-acquisition-date compensation.

Additional guidance to keep in mind when applying these steps includes:

y Requisite service period in the context of these steps has the same meaning as it does in the context of Topic 718.

y When apportioning the replacement awards’ Topic 718 value between consideration transferred and compensation, the buyer should take into consideration its expectations about the number of awards for which the requisite service will be rendered (i.e., its expectations about vesting).

y The steps are the same regardless of whether the replacement award would be classified as a liability or equity based on the provisions in Topic 718. For those awards classified as a liability, any acquisition-date changes in their value, and the related income tax effects, are recognized by the buyer in its

post-acquisition-date financial statements (i.e., the changes do not affect the accounting for the business combination). Accounting for the income tax effects of replacement awards classified as equity presents additional challenges. These challenges are discussed in FASB ASC 805-740-25-10 and 11 and FASB ASC 805-740-45-5 and 6.

y To the extent all requisite service related to the target’s awards has been rendered by the acquisition date and the replacement awards do not include a requisite service period, the buyer may ultimately recognize compensation expense immediately after the acquisition occurs if the Topic 718 value of the replacement awards exceeds the portion of that amount attributed to precombination services (the amount

determined in the fourth step) (see Cases 1 and 4 later in Example 13-7).

y To the extent the business combination causes the target’s awards to expire and the buyer is not obligated to replace those awards, any share-based payment awards the buyer chooses to grant to the target’s employees would be accounted for separate from the business combination and the Topic 718 value of those awards would be attributed to the postcombination financial statements.

y If the replacement award has a graded vesting schedule, the buyer must take into consideration its policy election for other awards with graded vesting. FASB ASC 718-10-35-8 discusses this policy election.

y After the acquisition date, the amount of the replacement awards’ Topic 718 value attributed to post combination service is accounted for under the provisions of Topic 718.

Example 13-7: Various replacement awards

FASB ASC 805-30-55-17 through 24 provide four cases focused on determining the portion of the replacement awards’ Topic 718 value attributable to: (a) precombination service (and, therefore, included in consideration transferred for purposes of accounting for the business combination) and (b) postcombination service (and, therefore, accounted for as compensation after the acquisition date and not reflected in the accounting for the business combination). The key facts from those cases and the conclusions are summarized in the following table to provide insight on the way in which the accounting for replacement awards varies based on changes in certain facts.

For additional information on and discussion of this example, refer to the examples in FASB ASC 805-30-55-17 through 24.

Note 1: The facts for Case 1 indicate that 100% of the target’s awards’ requisite service period had been completed prior to the acquisition date and that there was no requisite service period for the replacement awards. Based on these facts: (a) 100% of the target’s awards’ Topic 718 value would be attributable to precombination service and included in consideration transferred and (b) the difference between the replacement awards’ Topic 718 value and the target’s awards’ Topic 718 value would be attributable to postcombination service and treated as compensation.

Note 2: Because no postcombination service is required of the employees in this case, the amount attributable to postcombination service would be recognized as compensation expense immediately after the acquisition takes effect.

Note 3: After the acquisition date, these amounts would be accounted for in accordance with Topic 718.

Step 1:

• Topic 718 value of buyer’s replacement awards at acquisition date

• Topic 718 value of target’s awards at acquisition date

Step 2:

• Precombination service period (i.e., the portion of the target’s awards’ requisite service period completed prior to the acquisition date)

• Length of the replacement awards’ requisite service period

• Total service period (C + D)

• Target’s awards’ service period

• Longer of total service period and the target’s awards’ service period (if E > F, use E;

if F > E, use F) Step 3:

• Ratio of the precombination service period to the longer of the total service period and the target’s awards’ service period (C / G)

Steps 4 and 6:

• Amount attributable to precombination service and included in consideration transferred (H x B)

Steps 5 and 6:

• Amount attributable to postcombination service and treated as compensation (A – J)

Case 3