How are changes in estimates treated?
Statement 123(R) requires a company to make its initial estimate of the requisite service period at the grant date (or the service inception date if that date precedes the grant date). A company may then adjust that initial estimate in light of changes in facts and circumstances. A change in the estimate of requisite service period under Statement 123(R) may be treated prospectively or as a cumulative catch up adjustment in the period of change depending on the nature of the change. Statement 123(R) distinguishes between the accounting for changes in estimates as follows:
- Changes to outcomes affecting the grant date fair value or quantity of instruments that vest (e.g., change in exercise price, a vesting condition becoming probable, or an increase/decrease in the number of instruments expected to be forfeited). These types of changes are accounted for in the period of change as a cumulative effect adjustment on the current and prior periods, as if the change had been known at the grant date. To illustrate, assume a company grants 100 options with an exercise price of $20 per share that vest over three years if the company reaches certain targeted earnings goals. During year 2, the company realizes that it probably will not reach its earnings goal for the year and thus, should revise its estimate of the number of options that will be forfeited. To account for this change in estimate, the company would record a cumulative catch-up adjustment to reverse the compensation cost previously accrued relating to the options previously expected to vest.
- Changes to the requisite employee service period for which compensation cost is already being attributed (e.g., an initially estimated requisite service period changes because a different market, performance, or service condition becomes the basis for the requisite service period). These types of changes require any unrecognized compensation cost at the date of change to be recognized prospectively over the revised requisite service period, if any. To illustrate, assume that a company grants options with a grant date fair value of $1,000 that vest if the company achieves Stage II clinical trials for its product. For each of the first two years, the company expects to achieve this goal in five years. The company applies straight-line amortization and records $200 of compensation expense in years 1 and 2. In year 3, the company believes that it will now take six years (from the date of grant) to achieve the performance condition. While there is no change to the grant-date fair value of the award, the company should revise its estimate and recognize the remaining compensation expense of $600 prospectively over the remaining four years of the revised implied service period at $150 per year.
As a reminder, the ultimate goal of Statement 123(R) is that the final measure of compensation cost for an equity award should be based on the amount estimated at the grant date for the condition or outcome that is actually satisfied.
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