Derivatives Implementation Group

Statement 133 Implementation Issue No. C3

QUESTION

Are equity instruments (including stock options) that are granted to nonemployees as compensation for goods and services in share-based payment transactions subject to Statement 133?

RESPONSE

Issuer’s Accounting

Yes, for the issuer, once performance has occurred (as discussed in EITF Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services") and provided that the scope exception in paragraph 11(a) of Statement 133 does not apply. From the perspective of the issuer, equity instruments (including stock options) granted to a nonemployee for goods and services in share-based payment transactions are not included in the scope of Statement 133 if performance has not yet occurred. Paragraph 11(b) of Statement 133 (as amended) states that, "contracts issued by the entity that are subject to FASB Statement No. 123 (revised 2004), Share-Based Payment," are not considered to be derivative instruments for purposes of Statement 133. Any equity instrument granted in a share-based payment transaction subject to Statement 123(R) and its interpretive guidance for the reporting entity is not considered to be a derivative instrument subject to Statement 133 by that entity during the period that the equity instrument is subject to Statement 123(R) and its interpretative guidance.

Statement 123(R) contains the concept that equity instruments that are granted in share-based payment transactions may initially be subject to that Statement, but after certain events or circumstances, those equity instruments may cease being subject to that Statement. For example, paragraph A231 of Statement 123(R)¹ states, "A freestanding financial instrument ceases to be subject to this Statement and becomes subject to the recognition and measurement requirements of Statement 150 or other applicable GAAP when the rights conveyed by the instrument to the holder are no longer dependent on the holder being an employee of the entity (that is, no longer dependent on providing service)." Issue 96-18 provides guidance for accounting by the issuer for certain share-based compensation arrangements granted to nonemployees for goods and services, as noted in Statement 123(R), including guidance regarding counterparty performance commitments and conditions in share-based payment transactions. EITF Issue No. 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock," states the following:

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¹FASB Staff Position FAS 123(R)-1, “Classification and Measurement of Freestanding Financial Instruments Originally Issued in Exchange for Employee Services under FASB Statement No. 123(R),” defers the guidance in paragraph A231 of Statement 123(R) for employee awards under certain circumstances and provides additional guidance about when those awards cease to be subject to Statement 123(R). The terms of an award that ceases to be subject to Statement 123(R) in accordance with that FSP should be analyzed to determine whether the award is subject to Statement 133.

Thus, an equity instrument (including a stock option) granted to a nonemployee for goods and services in a share-based payment transaction would typically cease being subject to Statement 123(R) and its interpretive guidance after performance has occurred. At that point, the scope exception in paragraph 11(b) would no longer apply. The issuer would then need to determine whether that equity instrument meets the definition of a derivative and is within the scope of Statement 133 by analyzing the terms of the instrument. The scope exception in paragraph 11(a) may apply. That paragraph states that "Contracts issued or held by [the] reporting entity that are both (1) indexed to its own stock and (2) classified in stockholders’ equity in its statement of financial position" are not considered to be derivative instruments for purposes of Statement 133. EITF Issue No. 01-6, "The Meaning of ‘Indexed to a Company’s Own Stock,’" provides guidance about the application of paragraph 11(a).

Holder’s Accounting

Yes, for the holder. The exception in paragraph 11(b) of Statement 133 does not apply to the holder of those derivatives. Thus, equity instruments (including stock options) received by nonemployees as compensation for goods and services are included in the scope of Statement 133.

EFFECTIVE DATE

The revisions made on December 15, 2004, reflect the issuance of Statement 123(R). The effective date of the December 15, 2004, revisions to the implementation guidance in this Issue for each reporting entity is the first day of the fiscal quarter in which that entity initially adopts Statement 123(R).

The above response has been authored by the FASB staff and represents the staff’s views, although the Board has discussed the above response at a public meeting and chosen not to object to dissemination of that response. Official positions of the FASB are determined only after extensive due process and deliberation.