Attribution of Expense for Stock Options with Graded Vesting
‘Attribution of Expense’ means amortization of expenses.
In ‘Cliff vesting’ a certain percentage vests periodically after an initial period, commonly known as the cliff period. In ‘Graded Vesting’, employees vest a certain percentage of their accrued benefits in stages, without any initial cliff period.
The fair value of stock options is determined by using Black-Scholes option pricing model.
FASB Accounting Standards Codification Topic 718 (formerly FAS 123R), Compensation-Stock Compensation, allows that once the expense is determined, it is to be amortized using either Multiple or Single Attribution approach as:
Dr. Stock compensation expense
Cr.Contributed Surplus/Additional Paid-In Capital
A Single Attribution approach is a straight line approach which takes the total stock compensation expense for the entire grant and divides it evenly from the grant date to the final vesting date.
A major drawback of this approach is that it does not take the vesting commencement date into consideration. In most new startups, vesting precedes grant date. Most employees vest a certain percentage on their hire date whereas the board approval of the grant takes place at a future date. In such as case using a single attribution approach, will result in a shorter period of expense as compared to other periods.
In a Multiple Attribution approach, while the expense in each tranche (group of awards with the same features) is on a straight line basis, the expenses are front loaded in early years which results in an accelerated amortization during these early years.
Example of Single Option vs. Multiple Approach to Attribution
Assume a grant of 400 stock options with fair value of $5 determined using the Black-Scholes model. The options vest annually over a 4 year service period.
In a Single Attribution approach, expense is recognized on a straight line basis i.e. there is an expense recognition of $500 ($2,000/4) evenly over 4 years.
Whereas, a Multiple Attribution approach front loads expenses in the initial years as follows:
The table above shows the percentage of compensation expense recognized each year when an award has a vesting period of 4 years and is divided into four separate tranches.
Determining which method is appropriate for a company depends upon the attributes of the grant. The company management should make a policy decision and apply the method consistently to awards with similar features.
About The Author
Arushi Bhandari is an MBA and a licensed CPA in the state of California. She has helped several Silicon Valley startups at different stages with their accounting and tax related issues. Her publications eBooks - STARTUP Financing, Equity and Tax and Introduction to Equity Compensation are available on Apple iBookstore, Amazon Kindle and Google Play. She maintains a public blog at www.startuptaxaccounting.com especially aimed at startups, and has guest blogged at different startup platforms such as The Startup Garage and Belmont Acquisitions.
DISCLAIMER: The information provided is intended to educate the readers and a more definite answer should be based on a consultation with a lawyer or CPA. It should not be relied upon as legal advise because the information might be incomplete and answers could change depending upon circumstances and if all facts were known.